2023-11-23 04:00:02 ET
Summary
- Xponential Fitness is expanding its studios, growing membership licenses, and maintaining a low churn rate despite economic uncertainty.
- The company is strategically shifting towards high-margin international master franchise agreements and a move towards an asset-light model to boost profitability.
- Xponential Fitness has raised its FY 2023 guidance, projecting significant revenue and adjusted EBITDA increases, indicating a favourable trajectory.
In June 2022, I initially evaluated boutique fitness franchisor, Xponential Fitness, Inc. ( XPOF ). Over the past eighteen months, the company's market cap shifted from $705 million to $676 million, while negative market sentiment increased with a short interest of 21.02%, prompting a closer look. Contrary to the downward stock movement, the company's top and bottom line have shown upward trends reconfirmed in the latest Q3 2023 . Despite economic uncertainty, it is expanding its studios and growing membership licenses, and very impressively, it has a low membership churn rate. Although, I'm cautious about its high debt and ongoing efforts to improve its capital. On a positive note, the company has raised its FY 2023 guidance and is pursuing growth through master franchise agreements, international expansion, and potential brand additions. This upside potential and the company's immunity regarding low membership churn, when many customers are decreasing their discretionary spending, are why I maintain a bullish stance on this stock.
Company updates
Xponential Fitness has been strategically reshaping its approach to drive growth and financial stability. The company's shift towards high-margin international master franchise agreements and a move away from company-owned transition studios aims to boost profitability. Currently operating 2,980 studios and holding 6,000 licenses across ten brands, the company maintains a membership churn rate ranging from 1% to 3%, showcasing resilience in uncertain economic times. However, a decline in company-owned transition studios might affect certain revenue streams.
Aligned with the projected 17% growth in the $20 billion boutique fitness industry by 2025, the company's expansion plans seem well-positioned. With a substantial pipeline comprising 442 leases, over 2,000 sold licenses, and 1,000 master franchise agreements, the focus remains on global growth. While revenue streams diversify through franchises, equipment, merchandise, marketing funds, and services, we should be aware that services revenue will decrease due to the impacts of declining company-owned transition studios.
The company's international strategy, employing an asset-light model and fostering partnerships like the Kuwait franchise venture, aims to improve EBITDA margin in international markets. The long-term goal is a 20/80 international-to-global ratio.
If we look at growth potential in the near future, the company has increased its FY2023 guidance based on strong performance, projecting $305-310 million in revenue (a 26% YoY increase) and $104.5-106.5 million in adjusted EBITDA (a 42% YoY increase at the midpoint). Furthermore, the company aims for zero loss-making businesses by year-end, is currently restructuring, and has a lot of growth potential within the relatively new and untapped international markets for long-term growth. Another confidence booster is that although a premium product at premium pricing, members are proving sticky amidst an economically weaker environment.
Financial updates
Xponential Fitness demonstrates an encouraging upward trajectory in its TTM performance, showing improvements in both top and bottom lines, positive levered free cash flow, and surplus cash reserves. However, the notable increase in total debt raises concerns. It's important to acknowledge that this is a small, evolving company currently undergoing restructuring to enhance its operational efficiency.
Regarding Q3 2023 earnings, Xponential Fitness missed EPS expectations by $0.09, reporting a Non-GAAP EPS of $0.08, yet surpassed revenue forecasts with $80.4 million, marking a robust 26% year-over-year increase. Notably, TTM revenue reached a record $299.7 million, accompanied by a rising gross profit margin. This consistent growth trend in profitability has been evident since FY2018, which began at a 50.54% gross profit margin. Moreover, Q3 Adjusted EBITDA reached $26.5 million, constituting 33% of revenue, indicating a notable 33% increase from the prior year's $20 million, accounting for 31% of revenue.
In Q3 2023, the company reported a net loss of $5.2 million, an improvement from the $13.1 million loss recorded in the previous year. TTM net income stands at $4.8 million, representing the highest reported figure across all financial years and illustrating a notable positive trend in profitability over the past year.
YoY, annual cash from operations and levered free cash flow have shown an increase. TTM levered free cash flow stands at $31.7 million, indicating the company's ability to generate cash successfully. This potential can be utilised for debt repayment, rewarding investors, and reinvestment into the business, offering a positive outlook for financial operations.
Reviewing Xponential's balance sheet reveals $51.9 million in cash and cash equivalents alongside a total long-term debt of $329.7 million, primarily resulting from the repurchase of 85,340 shares. During the earnings call, management highlighted plans to enhance the company's capital structure while pursuing M&A growth strategies. Evaluating liquidity, the current ratio of 1.15 suggests the company can currently meet its short-term obligations.
Valuation
Assessing Xponential's stock value in its early stages presents a challenge. The wide range of valuations from analysts, swinging between $16 and $45, reflects the stock's inherent volatility. While Wall Street lauds it with a Buy rating of 4.30 and an average target of $27.69 , this diversity in estimates stems from the company's short track record, making cash flow predictions uncertain, coupled with the evolving boutique fitness industry landscape.
Though this volatility may heighten risk, a deeper dive into Xponential's potential reveals what I believe is a justifiable price. The company stands as an industry leader, holding a robust pipeline of future studios and leveraging sizeable master contracts, particularly in international markets. Its resilience during the upheavals of COVID-19 sets it apart from faltering competitors like F45 Training Holding and the traditional gym landscape. Furthermore, the company has set an ambitious three-year growth target , forecasting 2026 revenue of $405 million and Adjusted EBITDA of $190 million.
The anticipation of earnings doubling over the next few years paints an optimistic picture. Forecasts hint at an FY2024 EPS of $1.46, resulting in an attractive Price-to-Earnings ratio of 9.58.
In my view, this ambitious growth trajectory underscores Xponential's potential, despite the uncertainties inherent in the fitness industry. While acknowledging the risks, I see a company positioning itself for a resilient and prosperous future, aligning with what I believe to be a fair valuation given its growth prospects and strategic positioning.
Risk
Investors should be mindful of certain risks associated with the company. Seasonal fluctuations, notably lower performance during Q3 due to holiday trends, can impact revenue streams. The presence of net loss operating studios poses a current challenge, although the company aims to eliminate this by year-end. Moreover, the ongoing reduction and refranchising of company-owned transition studios, while a strategic move for long-term cost reduction, might lead to revenue impacts and substantial associated costs. The recent surge in SG&A by 48% year-over-year, primarily attributed to high operating costs from these transition studios and restructuring expenses, underscores the challenge of cost management.
Final thoughts
Despite ongoing studio restructuring, Xponential Fitness demonstrates positive trends with notable growth in studios and memberships, along with minimal churn. The upward guidance for FY 2023, projecting substantial revenue and adjusted EBITDA increases, indicates a favourable trajectory. The company's financial stability, growing TTM revenue, and consistent cash flow improvement suggest strong cash generation capabilities. While debt management remains a concern, my bullish stance is rooted in the company's evident growth prospects, especially evident in its global pipeline of leases, sticky customers, and talk of adding a potential new brand to the portfolio shortly.
For further details see:
Xponential Fitness: Building Stronger Foundations For Growth