Martyn Jones

Why low-cost gyms remain fit for our funds post Covid-19

Martyn Jones

Covid-19 has changed so much of our daily lives and we are only in the initial stages of tackling this pandemic. Our role as stewards of our clients’ capital is to take a long-term perspective and try to understand how this health crisis will affect our sustainability themes and the companies in our portfolios.

This article takes a closer look at one of our 20 themes, Enabling healthier lifestyles, detailing some of our analysis of what exactly has changed in recent months. With gyms re-opening this past weekend, we focus specifically on our investments in the low-cost gym space and explain why we believe they remain fit for our Sustainable Future funds despite concerns about their role as the world recovers.

As the name suggests, our theme aims to find companies that are enabling people to get more active and lead healthier lifestyles. Amazing advances in medicine have vastly increased life expectancy around the world but that means people are living longer with chronic illnesses like Type 2 diabetes and heart disease.

We are in dangerous territory for global health and many of these conditions are caused by lifestyles built around too much unhealthy food and too little exercise. One statistic that reveals the sheer scale of this is that, globally, the number of obese people has tripled over the last 40 years – with more than 1.9 billion adults now considered overweight. Several of our sustainable themes have their roots in such worrying data but we use this to sharpen our focus on companies looking to help improve such statistics – making the world cleaner, healthier and safer and generating strong long-term returns while doing so.

To be clear at the outset, many of our companies exposed to the Enabling healthier lifestyles theme have been hit hard by Covid-19, with gyms forced to shut and suffering drastically reduced revenues. Although gyms across Europe are now broadly operating again and the UK’s reopened on 25 July, there are questions about how quickly people will return, further peaks in infection rates, and the rise of home workouts (with the likes of Joe Wicks) – and we have been thinking hard about these factors and the long-term implications.

Our investment process starts by identifying structural areas of growth in the economy and then finding companies set to generate strong returns on capital from this growth over the next five to 10 years. While we recognise the risks in the gym industry and understand that the short term could be challenging, we continue to believe long-term demand for more active lifestyles will persist. As with many of our themes, we think the crisis is actually accelerating existing trends; in this case, the market share gains of the low-cost gyms that are technology enabled with virtual classes, offer at-home apps, have large national networks of 24-hour facilities and have access to capital markets.

Fighting an obesity epidemic

Global lockdown has enforced many behavioural changes, some positive such as working from home and others we see as more transient like physical inactivity while people have been cooped up. A recent UK survey, commissioned by Yorkshire Cancer Research, found levels of physical activity among the 2,000 respondents had fallen 25% during lockdown, with people reverting to more sedentary lifestyles.

But with underlying health conditions and obesity linked with higher Covid-19 mortality rates, we expect to see greater focus on our healthcare system and a renewed effort from society and governments to tackle unhealthy lifestyles and the UK has already begun its obesity crackdown this week.

Coming back to those alarming figures, the number of obese children globally is predicted to reach 250 million by 2030, up from 150 million now. If current trends continue, just one in 10 countries has even a 50% chance of meeting the World Health Organisation’s (WHO) target of no rise in juvenile obesity from 2010 to 2025.

Changes in adult obesity around the world

Anyone with a body mass index (BMI) of 30 or more is generally considered obese while 25 or over is deemed overweight and such a raised BMI can contribute to a range of non-communicable conditions such as heart disease and strokes, type-2 diabetes, musculoskeletal disorders including osteoarthritis, and many cancers. Looking to address this, the UN’s Sustainable Development Goal 3 has set a target of reducing premature mortality from non-communicable diseases by a third.

People are increasingly leading lifestyles incompatible with a healthy existence, eating calorific food and not engaging in enough physical activity. This creates what Dr Boyd Swinburn described as an ‘obesogenic environment’ in a 1999 Journal of Preventative Medicine article. Data from the WHO once again show that, globally, 31% of adults aged 15 or above (28% of men and 34% of women) are insufficiently active,  which is defined as doing less than five 30-minute sessions of moderate activity per week or less than three 20-minute sessions of vigorous activity.

Causes of this are numerous and they include a decrease in ‘active transport’ (walking or biking, although Covid-19 is bringing about change there), increased use of IT/sedentary behaviour-promoting devices, and little focus on physical activity in urban planning, work and school situations. As a species that has spent roughly 90% of its existence as hunter gatherers, homo sapiens are simply not designed to spend their lives sitting at desks and eating processed burgers.

Low-cost disruption in the gym world

From an investment perspective, gyms are an obvious beneficiary of the trend towards healthier lifestyles, offering the infrastructure for physical activity – workout and cardio areas, group exercise classes, sports facilities and personal training – in exchange for a membership fee. To put some figures on this, the global gym and health club market was estimated to be worth slightly more than $87 billion in 2018 and has grown every year since 2008 at a solid 4% to 5% according to data from the International Health, Racquet and Sportsclub Association (IHRSA). It goes without saying that Covid-19 has put an obvious dent in figures for 2020 and sent the industry into crisis mode.

As stated, a key part of our philosophy is looking into the future and trying to get ahead of developing trends. Within the gym space, a key structural shift has been in the rise of low-cost 24-hour operators witnessed in the US, UK and Europe – a classic disruption story. Clayton Christensen and Joshua Gans, experts in disruption theory, would characterise this as supply-side innovation, akin to low-cost airlines Easyjet and Ryanair and discount supermarkets such as Aldi and Lidl.

If we focus on the UK, the tale of the tape is as follows: a gym and sports club market worth in the region of £5 billion, with roughly 7,000 gyms and clubs in operation and around nine million members, which equates to around 15% of the population. Many low-cost gyms first sprung up in the depths of the financial crisis in 2007-08, offering no-frills flexible membership at less than half of the price of traditional operators. When we initially worked on this theme, we said the market was ripe for disruption as low-cost providers undercut expensive incumbents. Post-Covid, we still believe this to be the case, although it will be the well-established low-cost players taking market share rather than a swarm of new entrants, and in the UK, this means The Gym Group and PureGym.

These large low-cost leaders have national flexible site networks, economies of scale that enable higher operating profitability and, crucially, access to capital markets; this has been a critical advantage in surviving the current period.

In our funds, we have a position in The Gym Group, which launched in 2008 with a business model to offer a high number of basic, well-equipped gyms in convenient locations around the country. With an average monthly discretionary income for a UK household of £800 across 2.3 people, this means £347 discretionary spend per person. The average gym membership of £50 therefore accounts for 14% of this versus just £18 for The Gym Group at a more manageable 5% of spend.

Beyond this basic cost advantage, The Gym Group also offers one-month rolling contracts (meaning people are neither tied in for long periods nor face heavy exit fees), 24-hour access, free classes and more equipment per square foot than more premium operators. What they do not have is the latter’s swimming pools and cafes, smaller add-ons like towels and shampoo, and other additional fixed costs.

More recently, we also added Basic-Fit to our portfolios, which has a similar profile across the Netherlands, Belgium, Luxembourg, France and Spain. Again, the company started up in 2008 with membership fees less than half the average at €20 per month, and a cluster strategy to add multiple units and dominate urban environments with a network of sites.

Going back to our original thematic work, we expect to see the gym market bifurcating into premium high-end players at one end (with David Lloyd and Virgin charging £80 to £100 a month in the UK and offering all the expected frills and niche classes that come with that) and low-cost disruptors at the other at just £15 to £20 a month.

Low cost gym sites as a of total sites of top 10 gym brands

What this is still likely to mean is the squeezing out of mid-market players – names including Fitness First, Nuffield and Bannatyne Health Club, which all charge in the £45 to £55 range – and these have already been shedding market share to the lower-cost disruptors. At present, the UK market is roughly split between these three categories but bear in mind how quickly the low-cost players have taken that share: in terms of numbers, they are already dominant, with close to 300 PureGyms dotted around the country and more than 170 Gym Groups versus less than 100 David Lloyds and around 40 Virgin Actives.

Once again with a Covid caveat, we also see an opportunity in companies making and providing gym equipment. While this can be a cyclical business and dependent on the replacement cycle (excuse the puns), there are recurring revenues from maintenance contracts and solid predicted annual growth rates. In this area, we added Italian fitness equipment manufacturer Technogym to our portfolios in 2019, with the company recognised as the highest quality and most innovative name in this fragmented market.

To reiterate, we believe the low-cost end of the UK gym market will consolidate around the two large players, both of which have strong enough balance sheets to weather the storm and have access to the capital required to manage their way through tough times. In contrast, we think smaller independent players at the low-cost end without access to finance and traditional gyms with high fixed costs and membership fees will both struggle, eventually seeding market share to The Gym Group and PureGym.

Engagement on the gig economy

In addition to investing in high-quality companies both enabling and benefiting from a more sustainable future, our process also focuses on engaging with management teams on the environmental, social and governance (ESG) risks and opportunities facing their business. The gym industry has been a focus of our engagement, specifically regarding the use of self-employed personal trainers.

In October 2017, MP Frank Field, chair of the Work and Pensions Committee, sent a public letter to The Gym Group’s CEO regarding the employment practices of personal trainers. The Committee expressed concerns around the use of self-employed trainers as part of more general questions about poor employment standards in the 'gig economy'. It felt the contract between The Gym Group and trainers was not consistent with self-employment and these were effectively employees without certain employment rights.

Following the letter, we have had several meetings and calls with The Gym Group’s management team asking for more detail on employment practices. They were already in the process of trialling employment contracts with personal trainers – culminating in the what the company has called the New Gym Team, an initiative that offers part-time employment to personal trainers with associated employment rights and benefits. This model has an annualised cost of around £1 million, and management also took swift action to support personal trainers during the lockdown period by topping up government furlough payments to 100% of their prior income.

Such a proactive approach to managing ESG factors is exactly the sort of behavior we expect to see from our companies and, while not perfect, we believe The Gym Group is leading in the sector for its treatment of employees.

Fitness and investing in healthier lifestyles post Covid-19

As we said at the outset, lockdowns across the world have been tough for the gym market. However, our view remains that the tougher the situation, the more those well-established low-cost providers will take market share, as they are already positioned to embrace home workouts and have lower operating costs and membership fees. If anything, we believe a challenging backdrop over the coming years could accelerate the shift towards lower-cost gyms dominating, albeit a much smaller group than predicted pre-pandemic.

When the serious nature of Covid-19 became clear, our first priority was to re-check the investment thesis for all our holdings to see whether they could survive a lockdown: key questions included the cash burn rate of a business, how much cash/debt it has and how close it is to borrowing limits.

We maintain confidence across our gym and fitness names and participated in the capital raising for The Gym Group as it secured more than £41.3 million in new funding to shore up its finances. With a company like Technogym, the shares have taken a hit and several of its customers will be cutting back or postponing planned capital expenditure. But repair and replacement cannot be postponed indefinitely due to the wear and tear on equipment as gyms start to re-open and we believe the long-term prospects remain strong.

In recent weeks, there has been rising media speculation about people not returning to gyms in the UK in July and potentially never going back; for us, this fundamentally misunderstands a generational and cultural mindset, particularly among users of the lower-cost options. Working out at home has clearly taken off but few people have either the space or finances to replace expensive and heavy gym equipment. Comments to ‘go and exercise in the garden’ are of little use to the thousands of people without ready access to outside space, particularly considering the average age of a Gym Group member is around 30 and a third are students. Those fortunate enough to have the option will also be far less inclined to exercise in their gardens during winter.

We welcome people doing more home workouts and running but see this as complementary to, rather than replacing, the gym for a range of basic physical reasons. It can be difficult to find a dedicated workout space, particularly in smaller homes with lots of distractions, and there are limitations in terms of equipment that can be used in a domestic setting: dropping a 30kg dumbbell on domestic flooring would do some considerable damage. Putting cost and physical issues to one side, there are further intangible reasons people like to work out at the gym, including the social benefits of exercising with friends or that extra bit of effort eked out in a competitive class setting.

Any return to ‘normality’ will be slow in the weeks and months ahead with social distancing still in place and there is no way of knowing whether we could see second or third waves of Covid-19. In the face of this, gyms may be facing a protracted period of lower footfall in addition to higher costs as they deep clean every day. But we continue to believe the desire to exercise more will persist and if we are facing a recessionary environment, lower-cost gyms, taking a smaller share of household spend, will be clear beneficiaries.

Much of our sustainable thinking at Liontrust focuses on a cleaner and safer world in the future but a third goal requires people to be healthy enough to enjoy this. With a fifth of the world’s population expected to be overweight or obese by 2025, and related diseases impacting both life satisfaction and expectancy, there are issues we simply have to face – and lockdown may have exacerbated this for many people despite the images of smiling garden workouts.

The response to Covid-19 shows how the world can overcome challenges through co-operation, applying ingenuity to positive ends and investing in businesses to deliver a positive impact, and there are obvious parallels with the obesity epidemic. On the Sustainable Future funds, we will continue to focus on companies working to reverse the world’s Obesogenic environment, whether through improving diets or people’s lifestyles in general – and, as with many of our themes, we would expect to see efforts on this front accelerate in the post Covid-19 world.

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Friday, July 31, 2020, 11:20 AM