Shares in low-cost, no-contract gym operator The Gym Group (GYM) are languishing 55% below pre-pandemic levels despite the firm seeing a recovery in site profitability and growing its estate by 40% since 2019.
In recent months the business has got itself back in shape and appears to be building strong growth momentum with like-for-like sales up 9% in the first half of 2024 leading management to raise its full-year 2024 profit guidance.
In March 2024, the company announced an accelerated site acceleration programme aimed at opening 50 sites over the next three years funded entirely from free cash flow.
We believe the depressed price offers an attractive risk/reward investment opportunity with the shares trading on a free cash flow yield of 12% based on Liberum’s estimates.
This low valuation could also attract a competitor or private equity buyer given the business trades around 15% to 20% below replacement cost, which looks anomalous given the strong track record of sites generating returns on invested capital of around 30% on average.
BIG GROWTH RUNWAY
The Gym Group operates 237 sites in the low-cost gym sector which is the only segment of the wider exercise market displaying growth. Low-cost gyms have increased by almost four-fold over the last decade according to a 2024 company-commissioned report by PWC.
Based on population growth, expansion of health and fitness and low-cost gyms entering wider catchment areas, PWC identified potential for a further 600 to 850 sites in the low-cost segment from 756 currently.
Management has identified the key characteristics of high-returning sites which are those in Greater London and urban residential locations. With a favourable rental market persisting and cost inflation abating, new sites are performing well against expectations.
The company is focused on yield management, which means getting more customers through the doors and increasing retention rates through targeted digital marketing.
Memberships reached a record 905,000 in the first half of 2024 while average revenue per member per month increased 9% to £20.44. The group increased the average headline rate of a standard membership by 8% in December 2023, but it still remains £2 per month cheaper than competitor PureGym.
Management sees scope to lower the price gap and improve yield by focusing on profitable promotions and increasing premium membership penetration, which grew to 31.7% in the half year from 30.7% at the end of 2023.
The company has a three-tier pricing model starting at £13.99 a month giving it flexibility to optimise price and enhance yield.
A 2023 study commissioned by the company showed consumers perceive it offers a high-value service at a low perceived price which demonstrates the company’s strong value-for-money proposition.
WHAT ARE GYM’S COMPETITIVE ADVANTAGES?
The Gym Group’s major advantage is its low labour intensity and high asset efficiency. For example, the company operates with just one or two staff for each of its sites and has built strong technology solutions to make a visit to the gym easier and more fun.
It doesn’t provide any wet facilities, which means no swimming pools, saunas or steam rooms. There are also no social areas or coffee machines, which means the company achieves higher revenue density and improved efficiencies.
Adding further to efficiencies compared with traditional gyms, its customers can use the facilities 24/7 which opens the gyms to a wider segment of society, for example shift workers, taxi drivers and participants in the ‘gig’ economy.
WHAT DO THE FINANCIALS LOOK LIKE?
Looking at the cash a business generates is more important than scrutinising profit, and with The Gym Group it is even more essential because the firm spends a lot of money up front to open and equip new sites.
Currently, high depreciation charges related to a growing estate and amortisation of leases are acting as a headwind (roughly £73 million) to reported pre-tax profit numbers. As the estate matures, these should turn into tailwinds.
The business is highly cash-generative, delivering £33 million of free cash flow in 2023 equivalent to 16% of revenue after charging £10.3 million for maintenance capital expenditure.
A key performance measure used by the company is adjusted EBITDA LNR (earnings before interest, tax, depreciation and amortisation less normalised rent) which was £38.5 million in 2023.
Liberum estimates adjusted EBITDA LNR will reach £54.8 million by 2026 representing annualised growth of 12.5% per year.
Optically, The Gym Group looks to be quite indebted but most of that is related to property leases. Non-property net debt (£54.6 million) to trailing EBITDA (£38.5), a measure of leverage, is a conservative 1.4 times, and Liberum forecasts this ratio will drop to one times EBITDA by 2026 as net debt shrinks and profit grows.
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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