Why This Fitness Club Operator has the Best Growth Prospects Among Its Peers

Staying healthy involves both having a proper diet and exercising regularly. Apart from organic and natural food retailers, health club operators are strong beneficiaries of the health & wellness trends. Among the listed companies, Life Time Fitness stands out as the best proxy for industry growth.

Mar 3, 2014 at 12:52PM

Life Time Fitness Exterior
Source: Live Life Active

According to a Gallup survey, the U.S. adult obesity rate (defined as BMI above 30) has increased from 26.2% in 2012 to 27.1% in 2013, which represents a new record high. At the same time, only one in five U.S. adults are meeting the federal government's weekly physical activity recommendations of a minimum of two and a half hours of moderate-intensity aerobic activity and 15 minutes of vigorous-intensity aerobic activity, based on a study by the Centers for Disease Control and Prevention.

As a result, an increasing number of Americans are hitting the gyms. According to data from the International Health, Racquet and Sportsclub Association, or IHRSA, U.S. health club revenues and memberships have registered five-year compound annual growth rates of 5% and 3%, respectively. The best is yet to come, though, with the current U.S. health club penetration rate still low at 17%.

This favors companies like Life Time Fitness (NYSE:LTM) and Town Sports (NASDAQ:CLUB). Between the two club operators, Life Time Fitness boasts superior growth prospects for the reasons discussed below.

Positioning that isn't dependent on location
While Town Sports positions itself as a convenient neighborhood health club operator with its 'where you live, where you work' club location-clustering strategy, Life Time Fitness sells the 'resort-like' environment of its health clubs. The different positioning of the two club operators plays a big part in their respective growth prospects.

To ensure that its clubs remain close to both its members' homes and work locations, Town Sports is more likely to to fill up its existing markets with as many of its clubs as possible. This is reflected in its future growth plans, as Town Sports has set a 2014 target of between four to six new sports-club openings in its core markets: New York and Boston. These two regions currently account for more than 85% of the total number of clubs that Town Sports operates. With only a handful of clubs in other regions like Washington and Philadelphia, Town Sports faces restrictions when it comes to expanding its club locations. 

In contrast, Life Time Fitness doesn't depend on location as much as Town Sports does. In fact, about a quarter of its members either live or work more than five kilometres away from the Life Time Fitness clubs where they work out. Since Life Time Fitness isn't constrained by the clustering strategy and it has a presence in 29 U.S. markets (versus four for Town Sports) its universe of available growth opportunities is much bigger than that of Town Sports.

Lease versus own
Both health club operators have pursued different paths when it comes to the decision between owning and leasing. Town Sports leases most of the locations where it operates. In contrast, Life Time Fitness owned more than 70% of the centers that it ran as of December 2013.

There are several advantages associated with owning rather than leasing retail locations. Firstly, there is always a risk of losing your prized locations when your leases are up for renewal. Secondly, even a tenant who stays at the same location is at the mercy of rental rate increases by the landlord. Thirdly, the retail leasing market tends to be much larger than the market for the purchase and sale of retail properties. As a result, a willingness to own properties will significantly expand the universe of potential retail locations.

ClubCorp (NYSE:MYCC) adopts a real estate strategy similar to that of Life Time Fitness. It owns the land and physical properties for more than 75% of its golf and country clubs. In addition to the aforementioned advantages, ownership of golf club locations is even more valuable because of the scarcity factor. Significant real estate requirements in terms of size and the 'not-in-my-backyard' mentality mean that it isn't easy for golf clubs to find suitable locations.

Furthermore, ClubCorp has the luxury of improving the customer experience at its owned locations without seeking permission from landlords. Examples include the additions of contemporary outdoor dining and fitness facilities as well as resort-like water features at certain ClubCorp locations.

ClubCorp owns the underlying real estate for more than three quarters of its golf and country clubs, which gives it control over prime locations that will accentuate its advantages. Furthermore, it is easier for ClubCorp to implement relevant capital improvements to its assets without the hassle of seeking approval from landlords.

Source: Life Time Fitness

Ancillary revenue
Life Time Fitness receives a higher proportion of ancillary revenues than Town Sports. While Town Sports generated about a fifth of its 2012 revenue from personal training, other classes, and the sale of sports products, Life Time Fitness derived close to 32% of its revenue from ancillary sources other than membership dues and enrollment fees.

Club size is an important factor in driving ancillary revenues. Town Sports' fitness-only clubs and multi-recreational clubs average around 21,000 and 38,000 square feet, respectively. Comparatively, Life Time Fitness' average square footage for its entire club portfolio is approximately 95,000 square feet. As Life Time Fitness migrates more of its centers to the new, larger format which averages 114,000 square feet, its average square footage should increase further. With larger floor areas, Life Time Fitness has a greater ability to configure its centers to maximize cross-selling opportunities.

Foolish final thoughts
The health club industry is expected to see strong growth in the near future, given the increased obesity rate and the relatively low penetration rate of health clubs. Among the listed companies, Life Time Fitness is the most well-positioned to benefit from these trends, given its location ownership strategy and its high ancillary revenue contribution.

The healthiest stock of them all
Identifying a good industry isn't enough; picking the right stocks within the sector is equally important. Life Time Fitness is my top pick within the sports club industry. 
The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Mark Lin 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.

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