BSFFF - Greystone Capital - Basic-Fit: A Category Killer With A Significant Growth Runway

Summary

• Basic-Fit was the rare situation this year.
• Basic-Fit stock became an easy sell, with shares declining nearly 50% from peak to trough.
• Recent data indicates that Basic-Fit is responsible for roughly a staggering 85% of incremental new unit capacity.
• As growth inflects, Basic-Fit will be trading for a low single digit multiple of EBITDA looking out a few years.
• I look forward to seeing what Basic-Fit will accomplish during 2023 - notably, our shares in Basic-Fit have increased nearly 30% in the past month.

The following segment was excerpted from this fund letter.

Basic-Fit ( OTCPK:BSFFF )

Basic-Fit was the rare situation this year where most of the share price decline was attributed to a self-inflicted wound during the company’s Q3 2022 trading update. As part of the update, guidance for FY22 surrounding membership totals, club count, revenues and EBITDA were all reduced, despite no mention of any deviations just two months earlier during their H1 2022 update. Compounding this blunder were the adverse macroeconomic conditions in Europe where high inflation, rising energy costs and consumer weakness caused market participants to panic, while making Basic-Fit’s growth plans seem ambitious to say the least. Fearing the worst, Basic-Fit stock became an easy sell, with shares declining nearly 50% from peak to trough.

While I am respectful of the efficiency through which the market can incorporate good or bad news into a company’s valuation, Greystone’s risk management framework is less concerned with share price movements in a vacuum, and instead attempts to identify potential adverse outcomes to a particular business and underwrite such risks appropriately. As a result, I spent a considerable amount of time speaking with competitors, service providers and former employees, while stress testing my assumptions and re-underwriting my projections for the business. Despite the massive fumble by management, I came away thinking that the long-term investment thesis and competitive positioning of the business has not been impaired. The path from where we are today to our desired outcome will not be a smooth one, but I believe BFIT still contains all the elements of a successful investment.

Basic-Fit survived a rough three years after the onset of COVID, and exited that period with some fresh battle scars, only to face significant energy price hikes due to an ongoing war, massive cost inflation and the possibility of a consumer-weakening recession. Elevated energy costs, rising wages and higher construction costs don’t bode well for a capital-intensive gym business, but Basic-Fit has a decent amount of flexibility- in their cost structure, is pulling levers to improve the model, and has rarely utilized any pricing power until recently updating their membership options during the back half of 2022. Keep in mind that anything negatively affecting Basic-Fit more than likely harms competitors as much or more, and as one of the only operators with continued expansion plans, industry weakness should allow Basic-Fit to grow stronger by absorbing higher percentages of members across their markets over time. Recent data indicates that Basic-Fit is responsible for roughly a staggering 85% of incremental new unit capacity in their core markets over the last twelve months.

Given that this is a unit-economics story, re-underwriting the business involved examining each cost line item and conservatively working through the risks and mitigants within this economic environment. I’d like to briefly outline the major expense categories for BFIT clubs and why I think the perceived near-term risks are overstated.

Energy (3-5% of revenues per club, varying)

Within Basic-Fit’s cost structure, energy prices remain the wildcard. Although the company entered into fixed price contracts for energy through the first half of 2023, that will soon expire. However, European natural gas recently touched near a two-year low of €60 euros per megawatt hour, declining to pre-Ukraine War levels. Management estimates prices would have to more than quadruple for them to have a significant impact on a per club basis. I take a more conservative approach and estimate that a doubling of current energy prices per club (from €25k euros to €50k) could negatively impact EBITDA by around 15% during the next 12-18 months. Mitigating this is the large club network in France, where over 50% of Basic-Fit’s clubs reside. France has some of the lowest inflation in all of Europe, and the government has effectively capped energy price increases to 15% for 2023. For the remaining clubs, price increases and additional membership share gains would have a similar positive effect on company EBITDA. Basic-Fit recently changed their membership structure to focus on selling their premium membership for €29.99 euros/month. The results have been largely positive to date, with 50% of new joiners choosing the premium option, and 32% of the membership base on a premium plan, up from 26% during the middle of 2022. Should their premium membership uptake prove sustainable, the resulting ARPU increases should help offset variability in energy costs.

Wages (16% of revenues per club)

Despite the minimal staffing required per gym, wages are another cost bucket that is set to increase for BFIT, although the company already pays around 8-10% above minimum wages in all their geographies. Should wages continue to rise by 10% per year through 2025, I estimate an 8% impact to EBITDA. The company has been active in reducing labor costs by managing schedules more tightly, eliminating staff on public holidays and using technology to offset the need for locations to be staffed with personnel. The company spent around €50k euros per gym to outfit the buildings with security cameras with the goal of reducing staff to 1 FTE per gym. Competitors tend to staff gyms that are half the size of Basic-Fit clubs with 3-4 employees. The labor efficiency bodes well for Basic-Fit in the event that wages continue to rise.

Rent (15-17% of revenues per club)

Rent is one of the cost items where I’ve penciled in small increases of 3% per year, with membership pricing mix more than offsetting these increases. There is room for rent costs to decline over time as changes in use habits post-COVID shifted the commercial real estate market in Europe, and BFIT is a preferred tenant able to sign favorable lease deals. In addition, the company can construct a new club in a range of square footage, something competitors can’t do, allowing them to be more flexible on locations or outfit an older building to fit a desired location. Competitors such as Anytime Fitness and Pure Gym have also confirmed the emergence of more attractive sites at lower rents than before the pandemic.

Growth Capital Expenditures

Despite the tough industry backdrop and continued delays in obtaining construction permits, BFIT has kept a lid on club construction costs which won’t exceed €1.2mm euros during 2023. They’ve made changes to the equipment mix, leaning toward more popular weightlifting-based machines, helping to put a ceiling on growth capex. Conversations with industry operators indicate that Basic-Fit has their expansion plans down to a science, as its incredibly difficult for competitors to manage even 50 new club openings per year, let alone 150-200 gyms. So it would be difficult to imagine the new club construction amount increasing over time and sacrificing the potent unit economics BFIT can capture.

Moving forward, Basic-Fit is increasing their marketing spend and ploughing forward on growth during a time when competitors are struggling as there continues to be a significant expansion opportunity given scale and the ample reinvestment runway inside of the efficient operating model. As marketing spend continues to pay off, the blue-sky scenario moving forward involves higher members per mature club than pre-COVID, with stronger membership yields (on the back of premium membership uptake), in which revenue per club could increase by 15-25% higher than management estimates.

Importantly, at any point during their growth in 2024 and beyond, BFIT would be able to pause growth capex, at which point I estimate they would be able to generate between €7-10 euros per share in free cash flow, which they could use to retire a significant portion of the share count. Although the path forward will not be without additional bumps in the road, I remain optimistic regarding what the business can accomplish. As growth inflects, Basic-Fit will be trading for a low single digit multiple of EBITDA looking out a few years and as a category killer with a significant growth runway, superior unit economics and a strong management team, I believe we will be rewarded over time. We have David Polanksy of Immersion Investments to thank for providing useful data during the writing of this position update.

Following the share price decline in November, founder and CEO Rene Moos, invested alongside us as the company’s largest shareholder, purchased an additional $3.3mm in shares. I would note Rene’s history of open market purchases is strong, having also bottom-ticked the COVID-induced decline. Our interests are very much aligned and I look forward to seeing what Basic-Fit will accomplish during 2023. Notably, our shares in Basic-Fit have increased nearly 30% in the past month.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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