Planet Fitness Must Come Down to Earth

The dad bod “exudes more sexiness and confidence now than ever before.” And if you believe that, we have a highflying gym stock to sell you.

It might seem odd that

Planet Fitness


PLNT -2.10%

sponsored a study reaching such a conclusion, but only until you understand the company’s business model. The “Judgement Free Zone” prefers customers who like the idea of exercise more than actual exercise. Average membership per gym has grown to 7,500. They can hold a fraction of that number. A typical facility hosts only 700 or so workouts a day, on average. Many members barely ever show up.

So why do they keep paying? The price is right at $10 for a basic membership and barely twice as much for one with enhanced benefits. This value segment of the gym business has boomed in tandem with offerings at the opposite end of the spectrum—boutiques such as Orangetheory that can run over $200 a month, or pricey equipment and subscription services such as Peloton.

Many don’t keep paying, though. Planet Fitness won’t reveal how many people quit in their first year—just that attrition is 1.5% to 2.5% a month after that. “We don’t even measure it,” says Chief Financial Officer Dorvin Lively. Independent estimates put gym churn at over 25% in the first five months. And canceling isn’t simple—seemingly by design. It requires an in-person visit or a certified letter rather than, say, a phone call or mouse click. So, while an impressive 14 million members pay dues, franchisees have to keep finding new ones. Nearly half of customers have never belonged to a gym.

Planet Fitness makes much of its money by keeping 7% of membership fees paid to franchisees, who control over 95% of its gyms. It raised its take from 5% back in 2017. No small part of its growth in the past couple of years has reflected this increase in what it charges. While franchisees keep showing up, though, there are limits to how high the parent company can take the fee without choking off growth.

In any case, Planet Fitness now gets nearly as much revenue selling franchisees equipment bearing its colors. That is a windfall when new gyms open but also in perpetuity because they must agree to replace cardio and weight equipment every five and seven years, respectively. The company makes a 23% gross margin on those sales and expects about half of equipment revenue to come from replacements in 2019. Equipment is also an indirect source of free working capital for the parent since franchisees pay first but only receive equipment several weeks later.

How would an economic slowdown affect Planet Fitness? Multiple competitors went bust during the recession and the International Health Racquet & Sportsclub Association says that average annual spending per gym member fell from $451 in 2007 to $413 in 2011. But Planet Fitness actually grew same-store sales at the time—possibly as people traded down and there were fewer competing budget-gym openings. Instead, it might experience a deceleration in gym growth and hence equipment sales. The company has doubled locations since 2014 to 1,859 and hopes to reach 4,000.

Any slowdown could shred the chain’s rich valuation.

In a possible foretaste, the stock plunged 10% on Wednesday morning after results beat analyst forecasts but management merely reiterated full-year guidance. The shares had surged by more than 350% since their initial public offering four years ago. They still fetch over 23 times projected enterprise value to earnings before interest, tax, depreciation and amortization compared to less than 9 times in the summer of 2016. Private gym transactions have occurred at far lower multiples.

It has been quite a run. Now it is time for shareholders to start sweating.

Write to Spencer Jakab at spencer.jakab@wsj.com

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