Robert vt Hoenderdaal
The following segment was excerpted from this fund letter.
Basic-Fit released their FY21 results in March which reflected a number of very positive developments including the resumption of club operating hours, the return to new gym construction, and the entrance into their newest market of Germany during the back half of 2022. The rollout into a new country will undergo a slower test period of 20 clubs, but Basic-Fit estimates that the fitness market in Germany has the capacity for 600 BFIT clubs over time.
This is unfortunate news for the struggling, debt-laden and low-growth McFit, currently the largest fitness operator in Germany, but great news for us. I continue to believe the path to 2,000 clubs by 2025 remains feasible, which will result in significant free cash flow generation starting with the business becoming self-funding during 2023.
Europe is currently undergoing its own set of issues most notably on the inflation and energy fronts. Regarding inflation and cost of capital, Basic-Fit has no need to tap the debt markets anytime soon, nor have they seen increased churn or the inability to open new clubs from either a cost perspective or as consumers get squeezed in areas like food and energy. Part of the appeal of being the low-cost provider is that BFIT’s membership pricing per month is a small portion of consumer’s budgets, pushing the gym membership down the list of costs consumers would eliminate during tough times.
On the company side, Basic-Fit is contracted with fixed prices through 2023 for things like utilities at each of their clubs, providing visibility through at least next year. In other words, they are not exposed to energy price hikes taking place in nearly all of their markets. While BFIT will experience slight wage increases, most of the increases involve minimum wage employees, and gym rent costs are capped in each of their contracts moving forward.
While there is a ‘wait and see’ element to the cost structure given the macro environment, I continue to believe that management is downplaying the potential operating leverage inherent in the business model with continued scale, as equipment costs, energy costs and investments in technology will reduce the total operating costs per gym. This is not being included in any valuation or unit economics discussions from management, despite the almost unavoidability of this happening should BFIT continue down their current trajectory.
Savings on leases should they occur will only add to the positive leverage. Despite the company’s strong competitive position and the positive developments, Basic-Fit can’t catch a break. The last two years for the business have been marred by the coronavirus, followed by the virus variants, the war in Ukraine, and even a short-lived set of headlines reporting the re-appearance of Monkeypox in a few of BFIT’s markets. Additionally, Europe is now undergoing its own set of issues most notably on the inflation and energy fronts.
So why would we want to own Basic-Fit? Despite the negative headlines, the last three trading updates for the company have reflected nothing but positive news as they work their way back to building clubs out to maturity and expanding geographically. Long term earnings power is intact. Furthermore, we paid a paltry price for that long term earnings power. Something below 10x owner earnings for just the current mature club base, excluding future growth.
Keep in mind that during any additional tough economic periods, BFIT may actually benefit from such dynamics. Government subsidies for small businesses have ended, and mom and pop gyms with their lack of scale and higher cost structures would have severe difficulty handling additional decreases in membership revenue. I have yet to find one competitor, executive, or industry expert that can help me dismantle the investment thesis for BFIT.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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