Talwalkars Better Value Fitness: Book profits

While some premium is justified on account of its unique business, valuations are high in relation to size of operations and fluctuating performance.



The fitness bug has caught the fancy of not only India's masses but its stock market investors as well. The stock of the only listed operator of fitness chains, Talwalkars Better Value Fitness (Talwalkars), has almost doubled in price from its initial public offering last April.

At Rs 235, the Talwalkars stock trades at a valuation of 47 times the trailing 12 month earnings. While some premium to the market and other consumer stocks is justified by virtue of the uniqueness of this business, these valuations appear too high, given the stock's smallcap status (market capitalisation of Rs 575 crore), limited scale of operations and inconsistent performance.

Talwalkars has posted a drop in net profits for the December '10 quarter and muted revenue growth. The effect of interest cost savings, which have propped profit growth so far, will wane in FY-12. Any fresh debt taken on to fund expansion will increase interest outgo. The company has charted aggressive expansion plans for the next few years, requiring high capital investments. With the roll-out of a new gym chain, a spike in promotion costs may be in the offing. Continued high inflation may also bite into consumer wallets, leaving lesser room for discretionary expenses. Shareholders can thus book profits in the stock of Talwalkars. We had given an ‘Invest' rating for the stock at the time of its Initial Public Offer (IPO). The stock has delivered a return of 88 per cent from its issue price.

Funding expansion

Talwalkars has expanded its fitness centres from 44 at the time of its IPO to 100 by end-March 2011. Funding for these has primarily come from issue proceeds. Plans are afoot to add at least 40 centres in FY-12. Besides this, the company has launched a value-chain called HiFi. These expansion plans hinge on two issues.

One, to bankroll expansion, the company has proposed an investment of about Rs 100 crore. A part of this can be met by internal accruals, calling for debt to fund the balance. Rs 20 crore in debt was repaid by way of issue proceeds, resulting in interest cost savings of 21 per cent for the nine months ended December '10, which was largely responsible for the near-doubling of profits in the period. FY-12 onwards, the effect of this interest drop would no longer be felt.

Further, rising interest rates in tighter liquidity conditions is likely to result in higher interest costs for the company. Aggressive expansion plans under such conditions have already troubled other retailers.

Two, the ‘Talwalkars' brand is well-established nationally. Entry into new and small towns is far easier with reputed brands. However, plans to to roll out the new value-brand ‘HiFi' in Tier II/III cities will require investments in branding and promotion.

The company will also face competition from small, local gyms, which already are value-for-money, besides city-wide chains. Operating expenses, therefore, could see increases. Membership in a fitness centre is also discretionary by nature and may suffer blips during slowdowns.

Financials

Revenues have recorded a 44 per cent compounded growth over the past three years to Rs 66 crore in FY-10, while net profits have grown 91 per cent to Rs 8 crore in the same period. However, this growth is largely due to the small-base effect and is likely to stabilise going forward. That consistent high growth is not assured can be gleaned from the low 4 per cent revenue growth in the December '10 quarter and an 8 per cent decline in net profits.

Operating margins are high, but tend to fluctuate considerably. Operating margins in FY-08 improved to 40 per cent from the 31 per cent the year before on control over employee and administration costs.

However, margins in FY-09 slipped to 36 per cent, also due to high employee costs. Margins bounced back to 43 per cent in FY-10 on regaining control over staff costs. Going forward, rising inflation and rapid expansion would result in elevated staff costs. Brand-building efforts would also lead to increase in operating costs.

Given the asset-heavy model, depreciation eats away a good 9 per cent of revenues. Net margins, therefore, have fluctuated between 8-13 per cent between FY-07 to FY-10. The nine-month period ending December '10 had net margins of 14 per cent.

The company's expansion plans indicate that depreciation is likely to remain high and could take away a chunk of the operating margins. Along with a possible increase in interest costs, significant improvement in net margins seems unlikely.

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