Activist investor Mick McGuire reported last week that his firm, Marcato Capital, acquired 7.2% of Life Time Fitness (LTM), the Minneapolis-based operator of 110 super-sized fitness centers nationwide. Although LTM stock is up 13% year-to-date through May 28, McGuire believes its stock price can do a lot more.
However, 2014 has been anything but rewarding for investors looking to benefit from the healthy lifestyle trend. In fact, it has been downright hostile. Life Time Fitness is one of the rare winners; you have to wonder if it can keep it going.
Should you follow McGuire’s lead and buy LTM stock? Or should you consider something other than Life Time Fitness? Let’s take a closer look.
Life Time Fitness — What’s to Like?
McGuire’s biggest interest in Life Time Fitness is its real estate. At the end of 2013 it owned 70% of its clubs (most without mortgages) valued on its books at $2.3 billion. CEO Bahram Akradi believes the market value is more like $2.8 billion, suggesting LTM stock is being held back by a lower valuation.
REITs such as Simon Property Group (SPG) and General Growth Properties (GGP) have enterprise values that are 20 times EBITDA, while LTM stock putters along at slightly less than nine times EBITDA.
If the real estate it owns is spun into its own REIT, Piper Jaffrey analyst Sean Naughton believes LTM stock is worth $74, considerably higher than its current price around $54. However, he isn’t especially confident in the spinoff.
A more likely scenario is that McGuire persuades Akradi to speed up LTM’s expansion. At the moment, the company is working on a club opening every other month with new construction costs slated between $320 million and $355 million for all of 2014. A new build costs anywhere between $35 million and $50 million depending on the location, size, etc.
A quick calculation suggests that the average large format Life Time Fitness center generates $12.9 million (114,000 average square feet multiplied by $113.48 per square foot) in annual revenue with a four-wall margin of 42.3%. Assuming the average center costs $40 million to build, Life Time Fitness can expect to recoup its investment within 8 to 10 years.
Currently, LTM has $929 million in total debt with just $360 million in mortgages, and its credit facility eats up the rest. Paying an average interest rate of 2.4%, it has more than enough cash flow to increase the number of openings each year. With just one location open in Canada, it could open several more while still barely touching the domestic market.
Given that its financial covenants allow for total debt up to four times EBITDAR and it currently sits at 2.97 times EBITDAR, Life Time Fitness could easily double or triple its mortgage debt without sacrificing its banking relationships.
Although Marcato acquired LTM stock at prices between $47 and $49 and it now trades within 5% of its 5-year high of $56.94, it’s easy to see why McGuire has taken such a shine to this healthy lifestyle company.
What About the Rest?
Motif Investing offers an investing motif called “Fighting Fat,” a portfolio which focuses on companies helping to fend off extra pounds, including Life Time Fitness. If you look at its performance year-to-date compared to the S&P 500 you’ll notice that it’s trailing the index by almost 10 percentage points. That’s because almost 21% of its portfolio is invested in weight management stocks such as Weight Watchers (WTW) and Nu Skin Enterprises (NUS) which have taken it on the chin so far in 2014, down 54% and 47% respectfully.
Bill Ackman’s continued attacks on Herbalife (HLF) and the FBI’s investigation into its business practices have hurt most stocks even remotely related to the health drink maker. Until the matter is cleared up, all of these stocks should be considered dead money. Even market darlings such as Whole Foods (WFM) and Hain Celestial Group (HAIN) are badly lagging the overall markets. While the healthy lifestyle trend continues, it seems investors have generally grown tired of it. Like all cyclical businesses, it might be some time before investor enthusiasm returns.
Bottom Line
Life Time Fitness isn’t perfect. Its attrition rate in Q1 for the trailing 12 months was 35.7% — 180 basis points higher than in the same quarter last year. Its business continues to face all sorts of competition, making it very difficult to deliver double-digit revenue growth.
Nonetheless, LTM stock should be considered an attractive investment at these prices because if either of Marcato’s ideas for the business come to fruition in the next year it will very hard to keep the price down. I expect some healthy stock gains over the next 12 months.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.
