Is This Fitness Operator a Good Buy Now?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently, Fool contributor Michael Lewis wrote about a fitness club owner and operator, Town Sports International Holdings (NASDAQ: CLUB). Town Sports has advanced significantly since 2009, from around $1.5 per share in March 2009 to around $13 per share in September 2012. However, the stock has retreated to around $9 levels of late, within striking range of its 52-week low. Lewis is of the opinion that it could be “an attractive buy” at its current trading price. Is it true? Let’s find out.

Business snapshot

Town Sports is considered to be the third biggest owner and operator of fitness clubs in the U.S., with 510,000 members and 160 fitness clubs under four brand names, including New York Sports Clubs, Boston Sports Clubs, Washington Sports Clubs, and Philadelphia Sports Clubs. The majority of its top line, $376.5 million or 78.8% of the total, was generated from membership revenue. Personal training revenue ranked second, with $65.64 million in 2012, accounting for 13.7% of overall revenue, while other ancillary club revenues were nearly $30 million, or 6.3% of the total. As Town Sports derived the majority of its revenue from membership dues, its performance is quite dependent on its ability to attract and retain members. Its annual attrition rate was 41% in 2012.

A declining quarter with Hurricane Sandy impact

Town Sports has experienced a decline in its comparable club revenue in two out of the last five years. In 2009 and 2010, comparable club revenue decreased 5.6% and 4.3%, respectively, due to the recession and its impact on consumer spending. In the fourth quarter of 2012, due to the negative impact of Hurricane Sandy, its comparable club revenue also decreased 1.1%. Total member count also dropped by 12,000 to 510,000 in Q4 2012.

Its fourth-quarter net loss came in at $453 million, due to nearly $3.2 million charges of fix asset impairment from four clubs that suffered from damages caused by Hurricane Sandy. A bad fourth quarter might be the reason behind Town Sports’ share price plunge. I expect that Town Sports could improve earnings in the first quarter of 2013, as the company probably will not incur impairment charges caused by Hurricane Sandy’s impact anymore.

What makes me worried about Town Sports is its weak balance sheet. As of December 2012, it had a negative stockholders’ equity of $55.5 million, while the cash on hand was $37.76 million. In addition, the company employs significant leverage in its operation. The debt was a whopping $310 million.

Peer comparison

At its current trading price, Town Sports’ total market cap is around $223 million. The market is valuing the company at around 5 times EV/EBITDA. Compared to its bigger peer, Life Time Fitness (NYSE: LTM), Town Sports seems to be much cheaper.

Life Time Fitness, the operator of more than a hundred centers under the LIFE TIME FITNESS and LIFE TIME ATHLETICSM brands in around 26 major markets in the U.S., is worth nearly $1.8 billion on the market. At a trading price of around $43 per share, the company is valued at 7.45 times EV/EBITDA. In terms of profitability, Life Time Fitness has a much higher operating margin at 18.5%, while the operating margin of Town Sports is only 9.37%.

Foolish bottom line

With a huge leverage, negative equity and a low operating margin, I do not think Town Sports could be a good fit in the long-term portfolio of value investors. Investors might buy Town Sports only to speculate on the expected improving operating performance in the first quarter of 2013. 

hoangquocanh has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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