Fairfax media recently reported comments from Deutsche Bank analysts indicating that Ardent Leisure Group's (ASX: AAD) 'health club' (read: gym) business had materially underperformed during the second quarter of financial year 2015.
(Ardent's second quarter ended on December 31, 2014)
As a result, Deutsche Bank maintained its 'hold' recommendation on Ardent, with a 2015 price target of $2.15 – a price Ardent is trading within a few cents of.
But what does this really mean for the company?
As Motley Fool writer/analyst Mike King recently pointed out, broker recommendations should often be taken with a grain of salt.
In this particular case however, Deutsche Bank looks to be right on the money in stating that Ardent's health club business was underperforming.
Ardent's health club business' earnings declined 11% in the first half of 2015, illustrating a massive competition increase for customers in the sector.
It seems Australia has gone gym crazy over the past decade, with the number of gyms, associated businesses (think supplement and nutrition shops), and exotic new classes (think Zumba, rock climbing, and mixed martial arts, among others) skyrocketing.
The number of gyms in my home town, a city of 172,000, has increased from 5 to nearly 30 since ~2009.
Rapidly increasing competition for a slowly growing group of gym users will likely see gyms competing on three measures: 1) convenience, 2) quality of offering, including variety of classes, and 3) price.
This transition will also likely see customers become less sticky as they shop around or are drawn into gyms with specific inducements, such as the promise of 'boot camps' or membership deals and so on.
It's not a good recipe for growing profits as competing on price will squeeze margins – just as happened to Ardent in the first half of this year.
Ardent is far from out of the race, but a renewed focus on convenience (location, 24-hour openings etc) and the quality of the health club offering will be critical to seeing the company maintain and grow its earnings.
Working to differentiate Ardent's gyms from other competitors on the market and ensure more sticky customers will also be important to the group going forwards.
31.6% of Ardent's Earnings Before Interest and Tax (EBIT) came from the health clubs in the first half of 2015, and investors should watch closely to see how the new CEO handles the situation.
While I am not diving into Ardent just yet, I remain confident in the overall prospects of the business – including the health clubs – and believe that today's asking price look like a fair value trade for a growing company.
