#GYM - Gym Group Plc - a leading provider of low cost gyms in UK. Facing cost pressures and demand headwinds but perhaps the valuation is overdone?
Recent insider buying from NED Richard Stables
Gym Group Plc (#GYM) - 102p
DESCRIPTION - The Gym Group is an LSE-listed leading provider of low cost gyms in the UK. The low cost end of the market is dominated by Pure Gym and Gym Group. The company has 223 sites in the UK representing approx 30% of the low cost market.
FUNDAMENTAL DATA - Market cap £180m @ 102p, EV approx £255m without counting property leases as debt.
INVESTMENT CASE - Whilst there are some headwinds from rising interest service cost on debt (higher UK interest rates), from rising utility cost inflation (energy prices), and from softening of consumer demand (cost of living inflation and working lifestyle changes), the valuation of GYM might have over-discounted these points and might overlook the otherwise defensive attractions of the business. Frequent gym goers should keep going to their low cost gym regardless of economic hardship, and there should be some trading down from more premium priced offerings as time goes by (despite not much of this seen in the latest trading update). Even assuming that 2022 £45m EBITDA consensus mentioned on August’s earnings call is now reduced to say £35m, it leaves Gym on c7x EV/EBITDA, which is at the bottom end of gym sector multiples (typically these businesses trade on c8-10x EV/EBITDA, but we should allow flexibility for the changing economic and valuation backdrop).
Insider dealing details
There has been one insider sale this year, and several buys from NED Richard Stables
Richard is a former accountant turned corporate finance adviser. His appointment was announced on 30 August 2022 in the RNS below which explains his background and implies how he came to be involved with Gym Group. His own private advisory firm, Fulcrum Advisory Partners, seems to have provided advice services to Blantyre Capital (a 12% shareholder in Gym, and a specialist in distressed situations) regarding the latter’s investment in Gym equity. Fulcrum Partners (essentially Richard himself) has agreed cash incentive payments if Gym’s share price reaches certain levels going up to 600p per share. The max cash value at those levels is equivalent to receiving 305k shares in the company, ie circa £1.8m.
Despite already having this significant incentive structure in place, Richard has been adding to his exposure by risking capital and buying shares on the open market as per the above table - spending over £120k since his appointment on 30 August.
When listening to analyst questions on the 9 Nov trading statement conference call (linked below in the additional resources section), it is clear that there are investor concerns regarding the net debt and leverage ratio levels during an environment of rising interest rates, especially when combined with rising cost base (energy etc) and a weaker economic demand backdrop. When reading bulletin boards, some investors are even worried about another equity raise. Therefore, given that the investor concerns are on topics of financial gearing and balance sheet, it is somewhat reassuring that this seems to be precisely Richard Stables’ area of expertise and yet he himself seemingly remains confident. Clearly however there is a certain amount of assumption in this thought process, which may prove to be wrong.
Gym Group had 838k members at end Oct 22, up 16.7% yoy. 21 new sites were opened year to date, 7 more to come before calendar year end (including 2 Fitness First conversions).
Slightly slower than expected membership recovery in the current year up to the end of October caused the stock to drop after the recent trading update on 9 November 2022.
We estimate that if 2022 EBITDA consensus was £45m at the time of the August interim results presentation, the new number might have fallen to something between £35m and £40m. If we use £35m and apply it to the current EV of c£255m (using only non-property-lease net debt) then the EV/EBITDA multiple comes out at c7x which seems attractive versus industry averages.
During the November trading update call, non property net debt of £68.5m at end October 2022 was guided by management to rise to circa £75m by end of calendar 2022. If you add this number to the current market cap you get to our EV of circa £255m. There is remaining liquidity of £24m within the committed credit facilities of £92.5m
Cost inflation - all fixed utility charges are hedged for 2023, and 63% of the variable utilities are also hedged. The company is just coming off a favourable hedge at end of October, and so expects 2023 utility cost to be double the level of 2022, adding roughly £9m per year in incremental cost. The trading update said that already ⅔ of this amount was built into the company’s 2023 expectations at the time, implying perhaps £3m additional utility cost expected for 2023 versus prior broker estimates.
Sites opened before the end of 2018 are sites that would have for the most part matured before covid. For these Gym Group is giving LFL membership stats against the equivalent month in 2019. For all 154 sites taken together, the membership stands at 90% of the end 2018 level at end Oct 2022. But digging deeper into this group, it includes 16 sites that are very workforce dependent and are only at 67% recovery. If you exclude these sites it takes the LFL for the mature cohort to 93% for the remaining 138 sites. Since 2019 none of the new openings have the characteristics of these 16 workforce dependent gyms, so the impact of this dynamic should only be diluted over time.
Sites opened up in years 2019, 2020, 2021 - the growth cohort - lost a lot of their members during covid and so effectively had to restart their maturation. These are now growing at the levels you would expect, and have reached around 85% of their expected membership volumes, and are expected to continue maturing and growing through to the end of 2023.
Sites opened in 2022 are growing membership as you would expect. Sites opened in H1 22 are already at around 85% of their expected membership volumes.
The cohort of 16 sites that are most workforce dependent (in office areas, with little residential) are still not back to pre-covid levels and the company has acknowledged that they may never get back there, due to the changes in workplace habits.
Gym is currently still planning to open 25-30 sites next year, but when pushed by analyst questions on the trading update call, management admitted that it was a possibility that the site rollout plan could be slowed if there was concern over the cashflow/debt service/leverage ratio levels against a tough operating environment. Given the stock is no longer priced for growth, if the company said it was reducing the growth capex and focussing some of that capital on paying down debt instead, it would probably be taken as a neutral or maybe even a positive by the market. If the company decided to reduce the 25-30 opening plan for 2023, there is a sliding window of opportunity as they are currently beyond the level of full commitment on at least 10 of those 25-30 sites. Accordingly, we think shareholders would find out before the end of Q1 23 if there was going to be a material change in the plans.
Pricing - Gym has increased its headline price by 10.5% from £19.27 to £21.30, closing £2 of the £4 pricing gap versus the “immediate competitors” (Puregym, JD Gym) - this is the first part of the pricing strategy outlined at the Capital Markets Day. See slide below. Average revenue per member per month in the four months from July to October inclusive was up 5.5% year on year, lower than the headline price change because of the intentional strategy to go slower on price hikes for existing members to avoid any bad reactions that could lead to churn. Nonetheless the plan is to keep pressing on with the existing membership base to bring them up to target over a longer time period. The company’s trading update said they still expect average revenue per member per month to continue improving into the year end despite the seasonally quieter Q4 trading period.
The additional dynamic pricing strategy includes a plan to add price points both below the current bottom end of Gym’s range and above the current top end price level.
A re-branding project is underway, converting the brand from “Gym Group” to “The Gym Group”, which is hoped to make the brand more memorable and potent.
See below a selection slides on 2025 targets and a summary of the investment case from the perspective of the company itself.
RNS from Gym Group regarding Richard Stables joining the Board, and his remuneration incentives
Webcast recording of 9 Nov 2022 trading update
Half year 2022 results presentation, 4 August 2022
Capital Markets Day presentation 19 May 2022
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Any thoughts on why they talk about net debt excluding leases and EBITDA pre-IFRS16? Is the comps of 8-10x EV/EBITDA also adjusted for IFRS16 and lease liabilities? The impact of adjustments is quite big so I'm wondering if it's better to use FCF against EV (including lease liabilities). Guesstimating their FCF generation looks to be around 35-40mn so that puts it at 15x EV/FCF?
Ok thanks and that is all very reasonable. Not sure what you make of today's results although I would say again it is a little underwhelming; or maybe my point of view is incorrect?