LTH - Life Time Group Holdings: Continued Recovery With Better Profitability

2023-05-17 03:44:10 ET

Summary

• Life Time Group Holdings reported impressive financial results in 1Q23, with total revenue increasing by 30.2%. Adjusted EBITDA of $120.1 million also surpassed both consensus estimates and its own guidance range.
• LTH's strategy of regulating the number of members per location and implementing price increases has improved profitability.
• The company's pricing strategy, combined with operational adjustments, has contributed to significant cost savings and improved margins. Management expects these margin improvements to be structural.

Thesis

In my first post , I expressed optimism about the company because Life Time Group Holdings ( LTH ) employs a variety of strategies to ensure low expansion costs, the creation and maintenance of customer trust and loyalty, expansion into new markets, and the provision of complementary products or services. All of these strategies, when combined with the long-term uptrend in health and fitness, point to a brighter future for LTH. However, my concern at the time was that the stock was not cheap enough, and I anticipate that margins will increase to 20% in FY24. However, I was mistaken because margins expanded much faster than expected, 2 years ahead of schedule - FY22 EBITDA margin reached 21%. As a result, consensus estimates were revised higher, causing the stock to skyrocket. Following the 1Q23 results, I have revised my view on the stock, owing to the improved leverage target, continued membership recovery, and stronger margin outlook. At 12x forward EBITDA, I now recommend a buy rating, implying a 22% upside over the next 18 months.

1Q23 results

LTH reported robust financial results for 1Q23, with total revenue increasing by 30.2% year on year to reach $510.9 million. This impressive growth was primarily driven by a significant 24.6% increase in comparable center sales. Furthermore, LTH's adjusted EBITDA for 1Q23 reached $120.1 million, surpassing both the consensus estimate of $109 million and the company's own guidance range of $108 million to $110 million. This strong performance demonstrates LTH's ability to effectively manage its operations and generate healthy profitability. During the quarter, LTH witnessed a notable increase in center memberships, which rose to 764,000 from 674,000 in the previous year., LTH also successfully achieved an improvement in average center revenue per membership, which rose to $667 compared to $580 in the previous year. This increase reflects the company's ability to enhance revenue generation from its membership base.

Memberships growth

LTH's membership numbers, which are central to its business, have continued to be on the upswing , growing by 13% to 764k in 1Q23. Considering that LTH's membership is still well below its pre-pandemic peak of 846k, I expect growth to remain high in the near future as a result of LTH's recovery and structural growth. However, I anticipate slower structural growth than in the past as management attempts to regulate the quality of the club experience by limiting the number of members in each location. Members per center are therefore not likely to rise to their pre-covid levels (5.9k compared to the 4.7k seen today). While this seems bad, I am actually supportive of this strategy as it improves the profitability of each center, at the same time providing a better experience for LTH targeted group of members. The core part of the strategy is to increase prices (which will drive certain members away). As pricing has 100% incremental margin, the drop through to the operating profit line is huge. With members now using their cards an average of 11 times per month, up from 9 times per month before the pandemic, it's clear that the strategy is working. Net-net, LTH is now seeing recovery in memberships and better profitability.

Margin

The surprise to my previous model was a huge step up in margins. While I missed the opportunity previously, I am happy to see things turned for the better. As mentioned, pricing is a key part of LTH strategy which carries very high margins, and I expect the membership that are due to be updated to the new memberships pricing, which should continue to be a tailwind as the pricing increases appear well tolerated (NPS score increased and members increasing their frequency in swipes). Management has not only adjusted prices, but also its internal operations model. In particular, LTH has significantly adjusted its membership sales process, allowing it to generate significant savings relative to the previous commission structure. Also, since the emphasis is shifting toward digital channels, they have also revised the marketing program to achieve significant cost savings. The advantages to margins are expected to be structural, according to management.

Valuation

I have updated my previous model to reflect what I think is the upside for LTH stock today. The key changes here are the growth rates and EBITDA margin, and FY23 is anchored on consensus estimates. I now expect lower top line growth given the new strategy (volume is now going to be as strong), but profitability is going to further expand through FY25. I used the same valuation of 12x forward EBITDA (the average) for this model as well. But I would note that multiples could go higher as I expect LTH leverage ratio to continue moving downwards as the business recovers from the pandemic and the structurally higher EBITDA margins. The aim is to have leverage end around 3.5x net debt to EBITDA by end of this year. An important point to note is that $400 million (10%) of LTH debt is associated with assets under development. When these assets are fully operational and fully mature, the actual underlying leverage ratio is much lower.

Conclusion

LTH has demonstrated strong financial performance and positive developments in 1Q23. Membership numbers have continued to grow, with a 13% increase in 1Q23. While still below pre-pandemic levels, this growth indicates a promising recovery and structural growth. One of the surprises in LTH's performance was a substantial increase in margins. The company's focus on pricing adjustments and operational enhancements, such as revising the membership sales process and marketing programs, has resulted in significant cost savings and higher margins. With a 12x forward EBITDA valuation and expectations of continued recovery, stronger margins, and lower leverage, I anticipate a 22% upside over the next 18 months.

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