LTH - Life Time Group Holdings: Drop In Share Price Is A Buying Opportunity

2023-07-28 12:41:48 ET

Summary

• LTH reported decent earnings but saw a 10% drop in share price, presenting a buying opportunity.
• Delays in new center openings have impacted revenue, but management's plans to open more centers and focus on an asset-light strategy are positive indicators.
• LTH's efforts to reduce leverage and improve its balance sheet are encouraging, with expectations for continued decline in leverage ratio.

Summary

This post is to provide my thoughts on the Life Time Group Holdings (LTH) business and stock. LTH owns and manages fitness and recreational sports centers. They serve customers in the United States. LTH reported earnings 3 days ago, and despite the decent results and improved FY23 EBITDA guidance, the share took a beating, falling more than 10%. I believe this is an opportunity to buy the stock as I see the fundamentals improving, especially on the leverage aspect, which I expect to come down as the business grows.

Investment thesis

LTH reported $561.7 million in revenue for the second quarter of FY23, which was within management guidance but was on the low end. If the new centers had opened on time, revenue would have been higher. While this may look bad at first glance, I don't think there are any underlying problems with LTH's growth trajectory because the holdups are being caused primarily by permitting and inspections, with only a minor impact being caused by construction holdups. The lag was not caused by low profit projections or anything similar. This means that earnings will be carried over to the following quarter (if they are opened). Considering that management has stated that eight new centers will be opened by the end of the year, with five to seven of those centers opening in the next 90 days, I think they have made this a clear point that revenue recognition is only a matter of time. Consequently, I do not anticipate any sizable modification to expectations regarding revenue growth for FY24 as a result of the delay in new center openings. There may be a few weeks or months of impact in FY23 due to this delay, but the market is forward-looking (FY24 in this case), so the share price shouldn't have been too affected (which it did, hence, the buying opportunity).

In addition, I have high hopes for the LTH strategy, as management has increased its projected number of FY23 center openings from 10 to 12. This suggests to me that LTH was able to take advantage of asset-light opportunities in the market, such as being approached by landlords looking for a new tenant about opening a new center on favorable terms ( Oppenheimer 23rd Annual Consumer Growth and E-commerce Conference ). In the future, I see this as a chance for LTH to fuel further expansion.

This quarter's results also show that LTH is well on its way to a stronger balance sheet, with the leverage ratio trending downward thanks to adj EBITDA growth. LTH's leverage, as measured by its net debt to EBITDA on a trailing twelve-month basis, has been a major concern. The good news is that LTH's management is still intent on lowering leverage, and if the company meets its FY23 EBITDA projections, the leverage ratio will drop to about 3.5x. I anticipate further deleverage in FY24 as the eight new centers scheduled to open in 2H23 begin generating adj. EBITDA; furthermore, note that long-term, management is targeting leverage under 3.0x. LTH is expanding its number of centers.

Valuation

I believe the fair value for LTH based on my model is $45. My model assumptions are that: LTH will meet management's FY23 revenue guidance as the planned centers open up. Growth in the years ahead should mirror the same rate as LTH continues to execute its asset-light expansion strategy, but slightly lower as the revenue base gets bigger. As such, LTH should be able to generate around $3.2 billion in revenue in FY25. As I expect the leverage ratio to continue trending down due to increased EBITDA (profitability), LTH should be able to trade at a similar multiple to other peers within the leisure facilities service provider industry. I assumed LTH to be valued at 4x revenue, a slight discount, as it has lower profit margins.

Peers include: Planet Fitness, Xponential Fitness, and Vail Resorts. The median forward revenue multiple peers are trading at is 4.5x, the expected 1Y growth rate is 17%, and the leverage ratio is 4.35x.

Risk

While I believe the delay in centers is merely a blip in the growth trajectory, constant delays in centers opening could raise a red flag on management's ability to forecast growth, which might cast doubt on forward-looking statements. The market will then turn on its cautionary mode, which will pressure the stock price in the near term.

Conclusion

The recent drop in LTH share price presents a compelling buying opportunity. Despite the temporary setback caused by delays in new center openings, the company's fundamentals remain strong, with revenue growth anticipated once these centers become operational. Management's strategy to increase the number of center openings and focus on an asset-light expansion approach bodes well for future growth prospects. The company's efforts to reduce leverage and improve its balance sheet are also encouraging, with the expectation that the leverage ratio will continue to decline over time.

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