Finding Value in Town Sports

When looking for a good long-term investment, you want a business whose name is nearly synonymous with its industry. You want to own a business that generates cash -- and lots of it. And, perhaps most importantly, you want to pay as low a price as possible for that business, giving you a long runway for capital appreciation. Of course, these criteria are easy to spit out but much more difficult to accurately assess in reality. Let's look at a company that is appealing on the surface and see what lies beneath.

Membership models
As an investor, I find recurring revenue to be music to my ears. What better a way to do business than to make one sale that repeats itself 12 times a year in perpetuity until the customer cancels? That's the gym business, in a nutshell. As far as big-name gyms go, it can vary depending on region. But one that stands out in the Northeast is Town Sports International (NASDAQ: CLUB  ) . You might know it better as the New York Sports Club, Washington Sports Club, and other variations depending on the location. Town Sports has 108 New York locations, 25 in Boston, 18 in Washington, six in Philadelphia, and, naturally, three in Switzerland.

Recent report
In the company's most recent earnings report, things looked average -- the company missed EPS estimates by $0.03 at $0.12 per share and met revenue expectations of $114.2 million. More troubling, though, was that the numbers shrank across the board when compared with the prior year's quarter. EBITDA hit $100 million, which hit management's goal set at the beginning of the year. This marks an important milestone in the company's recovery from the financial crisis. The last time Town Sports had been able to achieve $100 million in EBITDA was 2008. It's important to keep in mind that this happened in a year when the company was greatly disadvantaged from the Hurricane Sandy catastrophe, which hit hard Town Sports' exact region. In the fourth quarter, and greatly influenced by Sandy, the gym lost 12,000 members.

While new memberships might be a drag on the company for the time being (the ever-popular New Year's signup was not as successful as the company had hoped), there's one area that is very appealing for future growth: personal training. PT revenue grew more than 5% in 2012 and represented 13.7% of the company's sales. PT is a cash cow for these gyms, and by the look of the numbers, it has plenty of room to grow for Town Sports.

Pay-per-use fitness options are also gaining more and more traction among consumers. Just look at how many CrossFits, Bar Methods, Soul Cycles, and the like have been popping up in every town across the United States. With the right mix of classes and equipment, Town could easily capitalize on this trend even more than it already has.

So the company is coming off a so-so quarter, but with some bright spots for the year as a whole. What will 2013 look like, and should you invest?

What lies ahead
While Town Sports didn't increase its club count in 2012, it looks like that should happen this year via opening new clubs and acquisitions -- including the West End Sports Club and five clubs in Boston under the name Fitcorp. For 2013, the company is aiming for eight to nine new clubs -- a substantial increase over its current 160. In 2014, the company is looking for six to 12 more clubs. Some simple math suggests two-year capacity increase of 9%-13%.

The long-term outlook looks compelling, in my opinion, but the short term will probably still feel the effects of Hurricane Sandy as well as soft consumer sentiment. Town Sports is expecting comparable club figures to be flat or slightly down in the coming quarter, along with soft figures across the board. Adjusted EBITDA for the first quarter is guided at $23.5 million, and on the bottom line, the company is expecting $0.15-$0.17 per share.

Town Sports is trading near its 52-week low and at a forward P/E of 11.22. On a trailing EBITDA basis, the company trades at only a 5.14 multiple. As evidenced by management's guidance, things should remain soft for the first half of the year, but I'm expecting things to tick up by 2013's end, based on a continued economic recovery, strengthening consumer interest in secular wellness, and expansion/acquisition efforts.

We may hate our gyms because after we sign up, we go maybe two times and then it's impossible to dig out of the contract. But Town Sports could be an attractive buy, considering it traded close to $14 before Hurricane Sandy.

As always, only invest in companies and industries you're familiar with.

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