2023-12-01 07:05:54 ET
Summary
- XPOF operates in a vast and expanding US boutique fitness industry, leveraging a multi-brand portfolio catering to diverse demographics, offering a long growth runway.
- XPOF’s capital-light franchising approach yields robust margins, positive free cash flow, and solid unit economics.
- XPOF's exceptional 3Q23 performance, with notable increases in total members, visitation rates, and system sales, signals a resilient membership base and stable growth trajectory.
Investment overview
I am bullish on Xponential Fitness (XPOF) as the TAM is extremely huge, which supports a long growth runway ahead for XPOF. Importantly, XPOF growth has been very strong even in the current macro climate and has a visible path ahead for the margin to continue expanding. So long as XPOF can continue to grow at this rate, I believe the market will start to attach a higher multiple to the stock.
Business description
XPOF is a multi-brand boutique fitness studio that mainly operates in the US. The company offers a variety of workouts across 10 brands, each appealing to different demographics, fitness levels, and interests. Workouts range from Pilates to cycling to yoga to running, etc. The company is ~100% franchised, adopts a capital-light approach, and generates strong free cash flow [FCF].
Large and growing industry that supports long-term growth
For a start, the TAM is extremely huge, just in the US alone. The estimated Gym, Health and Fitness Clubs industry size as of 2022 is around $31.3 billion . Historically, the fitness club industry saw increasing segmentation, with success at both the value and high end. For example, at the value end, success can be seen in Planet Fitness's ( PLNT ) success, which successfully drew in large numbers of first-time gym members. And at the high end, Equinox is a prime example of a luxury chain that showcases the demand for boutique studios. As such, within the larger industry, the boutique fitness industry is one of the fastest-growing , and I expect it to continue sustaining that status moving forward. There are a couple of reasons to support my view. At its core, boutique fitness has favourable demographic tailwinds. Talking about demographics, boutique fitness typically skews towards the younger age group, who are typically below the age of 30, and often skews towards women. Especially in the aftermath of the pandemic, I anticipate that these demographics will continue to enjoy rising disposable income and be eager to spend it on health and wellness. Second, one of the main reasons is that boutiques provide a one-of-a-kind opportunity for regular gym-goers to participate in activities that they might not have tried before because they were too intimidating or didn't fit their needs.
Presence in all states and multiple verticals ensures sustainable growth
I believe XPOF is well-positioned within the large and growing boutique fitness industry, as it is the largest boutique fitness franchisor in the U.S. XPOF has a presence in 48 states across the U.S. This ensures that XPOF is tapping into every single potential customer across the entire country. The most compelling aspect of XPOF's business model is its multi-brand portfolio, which allows the company to diversify its revenue streams, hedge against the inevitable decline of any one fitness fad, and adapt to changing customer tastes. This is a very important factor that impacts the long-term growth of XPOF, in my opinion, as it is extremely hard to shift the business model from boxing-focused to yoga-focused, for example.
Franchise model is attractive
Lastly, the one factor that I like about XPOF the most is that it operates an extremely asset-light franchised model with solid unit economics. Most people would know what a franchise model is, so I will not be digging deep into it. At a high level, the typical characteristics of a franchise model are that it has an attractive margin and a high FCF generation profile, which supports a regular return of capital to shareholders. For perspective, XPOF has gross margins in the range of 70%+, an EBITDA margin of 27% of the LTM, and has generated positive FCF since it went public. As XPOF scales, I expect margins to further expand. PLNT is the prime example to illustrate the margin potential of a scaled operator. At $1 billion in revenue, PLNT has an ~81% gross margin and a 46% EBITDA margin. With such a huge addressable market and growth potential, I am expecting XPOF to perform just like PLNT did.
Aside from the margin potential, another reason why I like XPOF's franchise model focus is that it offers protection from cost inflation. The cost of operating a gym is fairly straightforward. After the initial capex (equipment and renovation), the biggest cost of operating the gym is the labour (instructors, counterpersons, tc.). In the current macro environment, where unemployment is near its all-time low since the 1960s, wage inflation is a very tough thing to manage. Thankfully, for XPOF, this burden lies on the franchisees to manage.
Latest 3Q23 performance was outstanding as well
In 3Q23 , XPOF saw total members increase by 26% y/y and visitation rate up ~30% y/y. These led to system sales growth of 35% to $356.7 million, with same-store sales [SSS] growing 15% and 127 net openings. Strong SSS and a stable annual unit volume run rate of $564k (vs. $561k in 2Q23) drove a strong revenue performance to $80.4 million, beating the consensus estimate of $74.6 million. Consequently, EBITDA grew to $26.5 million and EPS to $0.90. Evidently, XPOF continued to grow very strongly, and I particularly note that the strong performance is stable, as evident from the increase in visitation rates vs. September. This should dispel any bearish view that the current trend of cutting discretionary spending (due to inflation and high rates) will impact the resiliency of XPOF's membership base. Looking ahead, based on XPOF historical seasonality, 4Q23 should see sequential improvement as it is the best quarter throughout the year.
On the margin outlook, we should see continued margin expansion as management continues to make progress in reducing company-owned transition studios, with 22 remaining at the end of 3Q23. Note that this is a major improvement from the 85 units in 2Q23. Looking ahead, the management strategy is to become more aggressive in re-franchising those still remaining in 4Q23, which makes me believe that this entire transition phase will be over by 1Q24. While these will be a headwind to revenue in FY24, I think it will be net positive as it will be a net tailwind to EBITDA, as management cited that these units are causing a $40 million drag to operating expenses in FY23.
Valuation
May Investing Ideas
I think the upside potential is pretty huge here (my PT is $29), and all XPOF needs to do is continue performing like it is doing currently. Key operating metrics like system sales, SSS, revenue, and margin expansion are all moving in the right direction. Importantly, the growth runway remains long, as the TAM is extremely huge. As such, I expect revenue to grow at the current pace of 20+% for the foreseeable future. The major inflection is in the EBITDA margin, where I expect it to reach 40+% territory over the next 2 years. For FY24, after the unit transition phase ends, operating expenses should trend toward a $110 million run rate (FY23 SG&A: $40 million). To get a sense of the normalised margin, using that $110 million for the LTM implies an EBITDA margin of more than 40%. If XPOF continues to grow at this rate, I expect valuation multiples to start inflecting upward. Currently, the stock trades at 7.3x forward EBITDA. To be conservative, I am only assuming a very modest increase in multiples to 8x (tracking towards PLNT EV/fwd EBITDA of 15x).
Risk
The SG&A leverage, which is critical to the growth of EBITDA over the next few years, would be significantly affected if XPOF sees slower unit growth. Boutique studio experiences may see a steady decline in demand as a result of increased competition from at-home fitness programmes, or large-scale gyms may offer comparable services.
Conclusion
In summary, I am bullish on XPOF due to its large TAM and robust growth potential within the US boutique fitness industry. Despite the challenging macroclimate, XPOF has exhibited resilient growth, projecting a visible path for margin expansion. The company's diversified multi-brand portfolio ensures adaptability to shifting fitness trends and demographic preferences. Leveraging an asset-light franchise model with strong unit economics, XPOF has a strong potential for the EBITDA margin to further expand.
For further details see:
Xponential Fitness: Huge Growth Potential Ahead At A Cheap Valuation