LTH - Life Time Group Holdings: Improving Results But Too Expensive

Summary

• Life Time Group Holdings shares have performed well over the past year, increasing 24%.
• With 25% of gyms having closed from 2019-22, Life Time's competitive position has improved. Revenue has increased as members have returned post-pandemic and Life Time has aggressively raised prices.
• While revenue per club has reached pre-pandemic levels, inflationary pressure has reduced profit per club.
• Following the increase in the share price, Life Time shares now trade at a lofty 22x free cash flow per share (ex growth capex) and appear fully-to-over valued.

Shares of Life Time Group Holdings ( LTH ) have significantly outperformed the broader market over the past year, rising 24% and significantly outperforming the broader market/S&P 500 ( SPY ) which has fallen 7%. Investors are enthused by the return of members post-pandemic and plans for future club openings.

While results have and should continue to improve (discussed below), this improvement appears to be (more than) fully reflected in Life Time shares which now trade at ~22x free cash flow (after stripping out new club capex).

Overview

After being taken private in 2015, Life Time took advantage of investor appetite for 'pandemic reopening plays' and came public again in October of 2021 at $18 per share. While the pandemic led the company to report significant losses as member revenue all but dried up, the Life Time has since seen a significant rebound (discussed below). While the pandemic had a negative effect on Life Time's business from 2020-22, it did improve the competitive environment as a reported 20-25% of gyms in th e US were forced to close.

The company operates ~160 premium health clubs throughout the US and Canada and expects to open another 9-10 per year. The cost to open a new location ranges from $50-60 million and management expects new clubs to generate $7-8 million in adjusted EBITDA at maturity (4 years after opening). Each club typically has 10,000+ members and monthly dues are now approaching $200 per month. In addition, 30% of Life Time's revenue comes from ancillary revenue including personal training, food/beverage, and merchandise.

Current Results

As shown below, Life Time is seeing a recovery in results post pandemic. The company expects that 2023 Adjusted EBITDA will be in-line with pre-pandemic (2019) levels.

While aggregate adjusted EBITDA for 2023 is expected to be in-line with 2019 levels, adjusted EBITDA per location is down about 15% versus pre-pandemic levels. While revenue per club is now at 2019 levels (shown below), inflationary pressure has increased operating expenses (rent, labor) which have impaired per-club profitability.

It is also important to note that while revenue per club has reached 2019 levels, membership per club is well below pre-pandemic levels. The company has significantly increased pricing (now approaching $200/month). To some extent the improved competitive landscape (due to aforementioned gym closures) has increased Life Time's pricing power. However, higher price points leave Life Time susceptible to both customer down trading (particularly in a tougher macro environment) and also may invite new competitors looking to steal members by undercutting Life Time's prices. Given the high fixed cost nature of the business, a decline in membership would likely have an outsized negative impact on EBITDA.

Valuation

At a price of $18, plugging in recent management guidance, I arrive at the following valuation multiples for Life Time:

It is important to note that I use maintenance capital expenditure (the amount of capital expenditure required to maintain existing stores and corporate overhead) rather than total capital expenditures, which would include an additional ~$450+ million (before of sale-leasebacks; sale-lease back transactions fund a good portion of new unit growth) to fund new location growth. Had I used total capital expenditures rather than maintenance capital expenditures, free cash flow per share would be negative.

It is also important to note that the above P/FCF is on a zero cash tax basis because of the large tax loss carry-forward Life Time accumulated as a result of the pandemic. I don't expect Life Time to pay cash taxes for 4-5 years.

To state the obvious, investors pay higher multiples for higher growth in free cash flow per share. To be consistent with using a multiple of free cash flow excluding growth capital expenditure, investors should compare the 22x multiple to expected same store sales. Given the dislocation caused by the pandemic, same-store sales growth for the past several years is not meaningful in estimating future performance (and from 2015-2019 the company was private). However, I think 3-6% is a reasonable estimate of normalized same store revenue/EBITDA performance given the company has demonstrated an ability to increase pricing to its affluent member base.

In my view, Life Time stock is fairly-to-slightly overvalued at 22x my estimate of ex-growth capex free cash flow per share. I think a valuation of 18x is more appropriate, which implies a fair value of $15/share. This takes into account Life Time's improved competitive position (due to industry closures), premium brand and positioning, and potential for future growth but is also cognizant of the negatives which include: potential member attrition (due to pricing/competition), high fixed cost leverage, and high levels of financial leverage (net debt is 4x EBITDA).

Conclusion

Life Time is seeing a nice improvement in results post-pandemic. However, my estimate of fair value is slightly below the current share price and I would not own LTH stock here. As a value investor I'd be potentially interested in taking a position at $10 per share, which is a 1/3 discount to my $15 fair value estimate.

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