Beach Bod Season

by Overheard Wall Street

    

Outline:
  • Intro
  • Health & Fitness Universe
  • Playing the Space
  • Planet Fitness
  • Peloton
  • Conclusion

Intro

Summer is not just right around the corner, it’s already here and if you haven’t gotten your beach bod ready yet – we have some good news for you: Focus less on the beach bod and more on the fitness industry as a whole. 

   

Every year, without fail, you can expect to hear about prepping your “summer bod” for the pools, the beaches and the outdoor activities that come with summer. Sure, “abs are made in the kitchen”, but let’s be real – pumping iron is what gets any of us excited about our summer looks. What better way to prepare yourself for summer than owning some of the companies dedicated to helping you reach your best summer potential. And better yet, avoiding some that may help achieve that summer bod but hurt your investment portfolio. Let’s get down to business with fitness!

Health and Fitness Universe

Health and wellness is important to everyone, even if it may not be your favorite subject. We don’t love being told that our regular midnight pizza snack or 13 cups of coffee per day is “unhealthy” – but that’s not our point today. The point is that this industry has some serious investment appeal – some businesses within this sector are considered “recession-proof” or, at minimum, “recession resilient.” This space is less commonly filled with high-flying companies banking on a wish and a whim looking to create the next “big thing” and more commonly filled with companies building something that appeals to everyone.

Rather we see companies that have heard the appeal from consumers and built a product or service to meet that need. These pleas include things like:
  1. I want to workout at a gym, but I don’t fit in with all these extremely fit people
  2. I don’t want to workout at a gym, but I want to feel like I am a part of a fitness community

    

Playing the Space

Each of the pleas by consumers actually leads us towards some companies that are doing something unique within the health and fitness industry. But, just because they are doing something unique or timely, does not always mean they are doing it incredibly well. We are going to look at a few names, two of which are very familiar to everyone – whether you are a fitness junkie or a FinTwit follower - you’ve probably heard these names: Planet Fitness (PLNT), Peloton (PTON).

Planet Fitness

Everyone knows the story of Planet Fitness – whether you’re a lunk who’s set off the alarm and been kicked out, or it’s the one gym you feel comfortable working out in without being judged. It’s a household name and that purple and yellow building color catches everyone’s eye! Planet Fitness operates a fitness center with over 2,200 stores nationwide with their primary goal being fitness access for all within their “Judgement Free Zone.”

The big draw for Planet Fitness, more than the judgment free zone (did they spell it wrong, or was that on purpose?) or the purple & yellow color scheme, is the extremely affordable price. All Planet Fitness gyms charge only $10/month for a membership. And remember, this is not your local rundown community center with 30-year-old equipment or rusted bars. Planet Fitness has state-of-the-art equipment that covers every muscle and fitness need you could imagine. All for $10/month.

Bulls
  • Planet Fitness had experienced 53 consecutive quarters of same-store sales growth through the first quarter of 2020 – the nationwide lockdown being the only thing that stopped their freight train of growth.
  • Differentiators:
    • A nationally recognized name gives them serious brand awareness in the US fitness industry. Everyone knows that Purple and Yellow logo!
    • Unique membership experience – most gyms appeal to the fitness junkies. The guys and gals who want to deadlift 500+ pounds or do 1,000 pull-ups without stopping. Those junkies are not the majority. PLNT appeals to everyone by providing a space where anyone and everyone can exercise without feeling judged just because the shredded dude next to them on the treadmill is running full-tilt uphill at max speed.
    • PLNT focuses more and more on their franchisee base to help stimulate their further growth. Franchisers account for 50% of revenue in 2021 and 100% of new store growth. By focusing more on creating a simple and easy-to-replicate franchise model, PLNT is able to continue its growth trend by making it relatively simple to set up a new store and start its cash flow machine.
    • Cash flowing machine – 90% of revenue is regular and recurring revenue streams for all stores, which includes more than just monthly member dues, but also royalties, vendor commissions, and annual fees. Planet Fitness has a Black Card membership that costs members ~$22.99/month (vs the standard $10/month) and provides access to additional amenities within the facilities – tanning beds, massages, and other discounts and promotions.

Bears  
  • Significant debt on the balance sheet may pose an issue for PLNT moving forward. They continue to grow and expand through the use of debt, which at some point may cause a squeeze on their ability to continually generate profits and maintain their margins.
  • The LTM PE ratio for PLNT is over 100 – in fact it stands at about 114, which is 7.6x higher than the average PE ratio of the entire S&P 500. Most investors view that as an extremely pricey asset. Although the company has strong operating results, in the market environment we are in – the company could be minting new influencers every week and investors would still view it as too expensive.

  

Catalysts/Risks
  • Franchisees have signed agreements with corporate HQ to open more than 1,000 stores, with 500 of them planned over the next 3 years alone. A 22% growth over the next 3 years, if executed on, would provide additional cash flowing operations and further expand the company's footprint.
  • Planet Fitness acquired Sunshine Fitness Growth holdings in February of 2022, which operated 114 franchisee-owned stores – integrating this model into their current franchising model and operations may be a challenging endeavor.

Key Metrics

Stock Price (as of 6/13/22): $64.26
  • EV/EBITDA (NTM): 20.4x
  • P/E (LTM): 117.4x
  • P/E (NTM): 44.6x
  • Balance Sheet Highlights (as of 3/31/22):
    • Total Assets: $2.992 bn
    • Total Debt: $3.2 bn
    • Total Equity: ($210 m)

Peloton

Nowhere in the history of the stock market have we seen a company’s stock price decimated because of the fact that some fictional character died in a fictional tv show while using the product. But that is exactly what happened to Peloton when the hit HBO show, Sex and the City, rebooted a new season and one of the main characters passed away while using his Peloton. It was so bad that the company issued an official memo to point out to investors that the bike did not cause his death. And even went so far as to hire that actor for an advertising spot to point out that he was not dead and wanted to use his bike again. I never thought I’d have to tell my children about that… but, here we are!

Peloton had an idea and a goal to bring the fitness community home with you – and it succeeded at just the right time: the height of the pandemic. At a time when people were either not allowed to leave their houses, or had no desire to be exposed to others in a potentially unclean environment, Peloton shined. Not only did they bring the exercise bike into everyone’s home – they included online fitness classes and competitions that allowed people to compete against each other and forget the fact that they were pounding that bike, alone in the unfinished part of their basements.

Peloton sells fitness equipment, mainly, along with a subscription to their fitness classes and mobile application. Their flagship piece of equipment, the exercise bike, is connected to their platform to allow for on-demand or live fitness classes. In FY 2021, Peloton delivered over 1.4mm units at an average selling price of $2,194 for a total revenue of $3.1 billion. On top of this, the overall churn that Peloton sees from their mobile application is under 1%. You would think this kind of revenue and client retention would be well-rewarded.

Unfortunately, Peloton went public just prior to the pandemic when everyone was desperate for at-home gym equipment and accessories. This made them a darling unicorn and their stock price exploded from an IPO price of $24/share to as high as $152/share at the end of 2020. Since then, the price has cratered hard – standing today at just under $10/share. Does this make it an interesting opportunity though?

Bulls
  • Peloton’s app has seen incredible adoption and provides a runway for customers from the cheaper subscription service to the more expensive hardware + subscription. The content that Peloton produces has a positive enough effect on customers that they believe they have built a solid pipeline for greater adoption of their exercise equipment down the road. The more customers start with the lower-end subscription-only service, the more likely they are to upgrade to the higher-end subscription and the hardware/equipment.
  • With a new management team in place, Peloton has reaffirmed its conviction and focus on its membership – which, even through the hard times Peloton has experienced with delivering assets – has continued to grow over time, in support of their ultimate long-term goal of 100 million paid members.
  • Peloton just hired a new CFO with a lot of experience in corporate finance, but the key is that her comp package is a strong signal that she believes in the future of the company. Her pay was a combination of $1mm salary + $9mm in stock - ½ of that stock coming in the form of restricted units and the other ½ in options that will only pay out for her if company stock reaches a certain threshold. For her to accept a comp package like this at a time where most investors hesitate to go near Peloton could be a very positive signal on the future growth of the company.

Bears
  • Peloton made a lot of mistakes during the pandemic with their meteoric rise in popularity and the demand they experienced. This high demand led them to massively increase their inventory of assets, raise prices and ultimately become stuck in a lurch of waning demand.
  • In early 2021, the company was operating at a net profit of approximately $114 million. In the first quarter of 2022, the company is standing at a $1.5 billion loss. That is a seriously wide margin in the course of one year, due mainly to poor management decisions on the back of a world “returning to normal” and leaving their Pelotons to gather dust in that home office.
  •  An activism campaign was launched in January of 2022 to replace the current CEO, who was believed to be the source of many of Peloton’s troubles, including:
    • Misleading investors by issuing $1bn of equity when additional capital was unnecessary
    • Shifting pricing strategies continuously to a point of confusion for all
    • Not working with safety agencies on a product that ultimately resulted in the death of 29 children
    • Purchasing an incredibly expensive office space directly next to his $55 million vacation home
  • The list of grievances against the CEO go on and are quite bad, but the additional piece of this activist campaign recommended the company be sold – immediately. It is never a good sign when activists come into your company and tell your board to fire the founder and CEO and sell the company immediately. Big red flags.

   

Catalysts/Risks
  • Peloton’s board did fire the CEO and hired a replacement, who appears to be working hard to focus the company on the right key areas (growth of the application as a funnel for hardware sales, rather than price shifting and ad campaigns). After only one-quarter of results, it already appears that the new CEO is making potentially solid strides. Unfortunately, the share price is still down 94% off its high in 2020.
  • The second part of the activist campaign recommended a sale of the company, and that does not appear to be off the table yet. There was a lot of talk of Apple or Microsoft buying Peloton, in the early days, to further enhance their edge as an operating platform and take further steps into the fitness industry.

   

Key Metrics

Stock Price (as of 6/13/22): $9.84
  • EV/Sales (NTM): 1.1x
  • Debt / Equity: 95.8%
  • Gross Profit Margin: 25.5%
  • EBITDA Margin: (31.1%)
  • Days Outstanding Inventory (Avg): 129 days (Up almost 2x from 1 year ago: 66 days)

Conclusion

Summer is about more than just getting shredded and looking great at the beaches - it’s also about finding the best investment in the health and fitness industry. It is important to recognize that fad diets and crash diets are not a long-term solution - they may provide some short-term solutions, but they are not moving you toward a more healthy and fit lifestyle. In the same vein - sometimes we want to avoid companies that have been beaten down and experienced a 94% loss because maybe the market knows a little more than we do. Maybe avoiding a company in freefall, like Peloton, is a smarter move.

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