S&P Global Ratings lifted its debt ratings on Life Time Inc., the operator of upscale fitness clubs, due to improving results.
Life Time earlier this month reported preliminary 2022 results in line with S&P’s previous base-case forecast and issued 2023 guidance for revenue in the $2.2 billion-$2.3 billion range and the company’s measure of adjusted EBITDA in the $430 million-$450 million range. S&P said it now believes the company’s EBITDA is comfortably covering its fixed charges, including maintenance capex, and forecast leverage to decline to the mid- to low- 6x area in 2023 from around 7.7x at the end of 2022.
As a result, S&P raised its issuer credit rating on Life Time to ‘B-‘ from ‘CCC+’. At the same time, it raised its senior secured issue-level rating to ‘B+’ from ‘B’ and our senior unsecured issue-level rating to ‘B-‘ from ‘CCC+’. The recovery ratings remain ‘1’ and ‘4’, respectively.
S&P’s positive outlook reflects its expectation that the company will end 2023 with leverage slightly below S&P’s 6.5x upgrade threshold, although a recessionary environment creates significant risk to its base-case forecast.
S&P said in its analysis, “The rating action reflects our expectation that Life Time is comfortably covering its fixed charges as of the fourth quarter of 2022 and that lease adjusted leverage could be in the mid- to low-6x area in 2023. Our base-case forecast incorporates the expectation that the company will end 2023 with dues and center memberships up approximately 10% compared with year-end 2022, which translates to memberships down approximately 5%-7% compared with year-end 2019. We anticipate the company will continue growing memberships in the mid-single-digit range in 2024 and onward as well. We also expect the company will increase its average monthly dues from paying center memberships to around $160 per member in 2023, and continue raising prices over time as it sheds legacy cohorts of members that are paying lower rates than new members. High flow-through of incremental revenue to EBITDA as the company has begun to cover its fixed charge base will likely result in higher EBITDA margin in 2023 and further improvement in 2024 to near pre-pandemic profitability level. We now expect the company to end 2022 with leverage of around 7.7x and leverage in 2023 to be in the mid- to low-6x area.
“Heightened recessionary risk in the U.S. and inflationary pressure could result in weaker-than-expected center membership, revenue and margin improvement in 2023; however, the company’s membership base has proven relatively resilient in past recessions. While our base-case forecast incorporates good revenue and EBITDA growth 2023, we believe our forecasted recessionary environment in 2023 could create risk to the company’s deleveraging path depending on the nature of the recession. However, the company’s revenue and EBITDA growth has remained relatively resilient through previous recessions, including the great recession where the company’s revenue and EBITDA grew despite a very difficult economic environment.
“Life Time plans to develop new clubs and intends to fund around half of the costs with the proceeds from sale leaseback transactions. We expect the company to use these proceeds to partially finance its growth capital spending over the next several years. We assume Life Time will spend approximately $550-$600 million annually on capital expenditure (capex) in 2023 and 2024, developing approximately 10 clubs per year. We also expect the company will close on approximately $300 million in sale leasebacks in 2023, and a similar amount of leasebacks in 2024. While we believe Life Time has adequate liquidity to fund its capital spending needs over the next several years, the timing of its club development spending typically precedes the closing of its sale-leaseback transactions, which creates incremental financing risk. We do not believe the company has seen difficulty closing on sale leaseback transactions yet, but rising interest rates and a recessionary environment in 2023 could make financing more difficult for Life Time. The company has also stated that in order to begin funding new club development with internally generated free cash flow it would need to hit around $600 million of EBITDA, and we believe incremental financing risk would be significantly lower if it could begin to generate EBITDA at that scale.
“We believe price increases could partially offset fewer memberships compared with historical levels and significant inflationary pressure. Life Time has significantly raised its monthly dues for new joins through 2022, and we believe the company will continue to do so for new membership cohorts in 2023 resulting in annual dues growth through at least the end of 2023. As a result, we believe the company could return to pre-pandemic EBITDA with a lower per-club membership base than it previously had before the price changes. However, given significant macroeconomic risk, this strategy could leave the company vulnerable to a recessionary environment and drops in consumer spending.
“Our positive outlook reflects our expectation that the company will end 2023 with leverage slightly below our 6.5x upgrade threshold. However, a recessionary environment creates significant risk to our base-case forecast.”
