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Home » Fitness » Planet Fitness: Extremely Leveraged And Low Growth Outlook – Seeking Alpha

Planet Fitness, Inc.'s (NYSE:PLNT) financial statements are as misleading as their ads and you need to read the fine print. Their ads say no commitment, but Black Card membership does require an annual commitment or you have to pay a $59 contract termination fee. PLNT's "earnings" are just as misleading. Are earnings per share $0.69 using their Non-GAAP approach or $0.50 using GAAP? Leverage has increased significantly and there is a very real possibility they could have a technical default on a bank loan covenant in 2020. Not only has their financial position significantly worsened since my article last summer, but insiders have been massive sellers of the stock. Their recent 10-K had some unfavorable data.

Financial Position Is Getting Worse

Bank debt increased $230 million in 2016 to a staggering $716.7 million after increasing $120 million in 2015. This compares to a negative shareholder equity of $215 million. A year ago, shareholder equity was "only" a negative $1 million. If you subtract out intangible assets ($254 million) and goodwill ($177 million), shareholder equity is a negative $646 million. (This gives an entirely new meaning to "financial leverage"!)

If interest rates rise sharply with the Federal Reserve raising rates, could this bank loan of LIBOR plus 350 become a future issue? The higher rates could also impact franchisees trying to finance new stores.

Why is the balance sheet much worse from the prior year? The special dividend of $2.78 per share ($271 million). In my opinion, it was purely a gimmick to pay TSG, the equity fund, additional cash at the expense of the future viability of PLNT.

Besides the bank debt, there is also a $419 million tax benefit arrangement liability payable to TSG and $106.7 million in leases. (I discussed the details of this tax benefit payment in my August article.) Collectively this makes their balance sheet extremely leveraged.

There is a very real possibility PLNT could have a technical default on their bank loan in the future. Currently, they are easily within the bank loan leverage ratio financial covenant of 6.5 to 1.0 of total debt to adjusted EBITDA (adjusted based on strict definitions in the agreement) at 4.3 to 1.0 in 2016. This covenant becomes much more restrictive and in 2020 it is 4.25 to 1.0. Some combination of higher adjusted EBITDA or lower debt in the future will be needed to avoid default and a need for a waiver because currently they would be extremely close to violating this covenant. While many investors are assuming growth, it does put pressure on the company. (A future default does not worry TSG because by then they will have most likely sold their entire PLNT holding.)

Low Growth Versus High P/E

Using 2016 GAAP earnings and the latest price of $21 per share, the P/E is 42x. That is a very high P/E, especially with such a weak balance sheet. Their growth in equipment sales and corporate-owned stores would not justify a high P/E. Most of their growth has come from franchise revenue. Equipment sales, which accounted for 41.5% of 2016 total revenue, was up only 3.3% in the 4th quarter and corporate-owned store revenue, which accounted for 27.7% of revenue in 2016, was up 5.1% in 4th quarter. Franchise revenue in the 4th quarter was up, however, an impressive 32.1%.

According to CEO Chris Rondeau, "...above 90% of our openings will be by the existing franchisees adding to their portfolio." He further stated, "We have a little bit of new blood here and there, but not a lot." Does that mean that once the number of stores is reached under existing area development agreements (ADAs), new store openings will plunge? According to the company, 1,000 new stores are to open over the next 5 years under the ADAs. I question if all these will actually be built because there could be a cannibalization issue of having a saturation of too many stores within an area and it may not be profitable to open another store. Already only 189 net new stores were opened in 2016 compared to 206 net new stores in 2015.

The company even lowered their advertising expenditures, net of amount reimbursed by franchisees, in 2016 to $8.270 million from $9.349 million the prior year. While this boosts 2016 income, lower advertising could have a negative impact on future results.

Management's outlook for 2017 adjusted EPS (Non-GAAP) was $0.72-0.75 (4.3-8.7% growth) compared to 2016 adjusted figure of $0.69. Total 2017 revenue was forecasted to be $405 million-415 million (7.1-9.8% growth) compared to $378 million in 2016. This implies shrinking profit margins, since revenue is expected to increase at higher rate than profit. This outlook of only very modest growth does warrant a high multiple for PLNT.

Equipment Sales

A major yellow flag reported in their balance sheet was the sharp decrease in equipment deposits to $2.17 million from $5.59 million Y/E 2015. It is also a drop from $3.99 million at the end of the 3rd quarter. Does that drop indicate weak 1st quarter equipment sales?

The franchise agreement requires the replacement of PF equipment 4-7 years, which on the surface would assure strong equipment sales growth over time. There are, however, a number of problems with this rosy expectation. First, a franchisee under the new agreement of 5% franchise fee versus the old agreement of a set $500/month may not have the capital to pay for the replaced equipment. (The franchise payment fees were changed in 2010.)

Assuming 6,500 members (55% Black Card and 45% regular membership) and four years of paying this 5% franchise fee on just monthly fees, a gym would pay $241,800 total in fees. This compares to only $24,000 in franchise fees for four years under the $500/month. This $217,800 difference could have a huge impact on a franchisee being able to have the capital to pay for the required replaced equipment. Those under the old agreement may have had an easier time affording replacement compared to how affordable the replacement will be in the future for those under the new fee agreement.

Second, not all equipment has the same ware/tear over time. There are major differences how often certain equipment is used or the amount of negative impact on the equipment per use. If franchisees are squeezed for cash they may assert that not all equipment needs replacement and push hard (litigate) against the company to modify this requirement.

Massive Insider Selling

Since my August article, TSG had two stock offerings of their holdings. On September 28, they sold 8 million shares@$19.62 and on November 22, they sold 15 million shares@$23.22.

CEO Chris Rondeau continues to exercise options and to sell stock. So far this year he has sold 146K shares. This begs the question: If he is so upbeat about PLNT why is he selling a lot?

Conclusion

In my March 2016 article, I covered PLNT's business model and the fitness industry. My August article covered their complex financial structure and included information about the tax benefit liability with TSG. This article was to alert PLNT investors to possible lower future growth and raise the issue about a potential future technical default on their bank debt.

I often write about bankrupt companies and there are almost always yellow flags prior to bankruptcy/restructuring that should have alerted investors to the direction the company was headed. Previously, I just thought that PLNT was just overpriced, but now I think that there is a potential for some type of restructuring within a few years.

With a lower growth outlook and a potential for a future technical default, I rate PLNT a strong sell. For investors willing to assume risk, I rate PLNT a short sell.

Disclosure: I am/we are short PLNT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

See the article here:
Planet Fitness: Extremely Leveraged And Low Growth Outlook - Seeking Alpha

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Home » Fitness » Planet Fitness: Extremely Leveraged And Low Growth Outlook – Seeking Alpha