U.S. Fitness Operators Benefit From Industry Tailwinds

We forecast solid demand recovery will continue to drive overall growth.   Fitness center issuers' revenue has benefited from a recovery in memberships due to an ongoing shift across the industry toward consumer spending on experiences and in-person fitness options. We believe both luxury and budget fitness operators will continue to benefit from good demand amid a growing focus on health and wellness among consumers. In contrast, mid-tier operators may face higher trade-down risk as consumer spending trends continue to evolve following multiple years of high inflation in a highly competitive and fragmented market.

The premium segment will likely remain strong as luxury offerings resonate with consumers' values.   Currently, there are no signs of a slowdown in the high-end fitness space. While total memberships still lag pre-pandemic levels, increases in both membership pricing and overall ancillary spending--particularly for personal training services--have led to a full top-line recovery for most high-end fitness operators. This supports further revenue and EBITDA upside for these issuers over the next two years. In response to members' growing desire to holistically integrate health and wellness into the fitness experience, high-end operators continue to expand ancillary offerings. For instance, over recent quarters, Life Time has introduced programs like Dynamic Stretch and MIORA, and opened numerous pickleball courts, reinforcing the value offering of high-priced, high-end fitness memberships.

Weight loss drugs such as Ozempic, Rybelsus, and Wegovy are still in early stages of widespread public use, and unknown future health risk factors are increasingly a focus; though, if they ultimately promote increased mobility, these drugs have the potential to be an integral part of a holistic approach to fitness. However, any material impact to membership trends or financial impacts due to the weight loss drugs has yet to materialize.

Relative resiliency within the luxury consumer space is generally consistent across industries, and we believe high-quality gyms and lifestyle brands still resonate with core members; however, given premium prices, we don't expect membership volume to fully recover to pre-pandemic levels before 2025. Throughout 2023, luxury gym operators successfully took aggressive price increases to offset lower membership levels compared with pre-pandemic levels. While some issuers believe there is still room for price hikes, we expect any increases going forward will be moderate, and membership growth trends could slow as even wealthy consumers may begin to feel inflationary fatigue.

Budget Players Are Poised To Benefit, While Mid-Tier Operators Are Most At Risk

Overall, we believe the greatest risk to member retention for mid-tier operators is the rise of boutique studios and no-frills, low-cost clubs.   While consumer spending is not wilting away as fast as previously expected, our most recent economic forecast for a moderation in spending in both 2024 and 2025 suggests that members may begin to trade down to value options to save money. More specifically, gym-goers may choose budget-friendly alternatives with fewer services that still satisfy their fitness needs, a targeted fitness option, or both. We believe this consumer evolution could pressure mid-tier fitness operators and lead to consolidation.

Therefore, large budget players are best positioned to benefit.   For example, rated budget operator United FP's membership base has recovered back to pre-pandemic levels, and brand owner franchisor Planet Fitness memberships are 18.7 million as of Dec. 31, 2023, which is 30% above 2019 levels. By comparison, mid-tier rated operator Fitness International's membership base likely still lags pre-pandemic levels, with the company reporting about 5.0 million total members as of year-end 2023, compared to 5.4 million members at year-end 2019.

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Higher Build Costs Could Slow Growth And Lead To Consolidation

We believe significantly higher build costs and higher interest rates through next year will result in a higher cost per square foot for new club builds, which could result in fitness center issuers pulling back on overall growth capital expenditures and the number of new clubs in development. This would potentially result in a moderation of new members over time and lower top-line growth.

However, there may still be significant opportunities for fitness issuers to take an asset-light approach. For example, converting currently vacant office spaces, malls, and competitor facilities that closed in response to the pandemic would require minimal capital expenditures, compared to the cost of new club construction and benefit from landlord support of initial upfront costs. Fitness center issuers who adopt this asset-light approach could introduce less stress to credit metrics and ultimately generate more free operating cash flow (FOCF), potentially alleviating the burden of higher financing costs in the current high interest rate environment. For example, Life Time Inc. recently shifted its financial strategy to include more growth from asset-light opportunities, which we expect will help improve its cash flow profile going forward.

Operators who struggle to adapt could become acquisition targets, leading to consolidation--especially in the highly fragmented mid-tier space. Most recently, Fitness International acquired XSport Fitness in July 2024, adding 35 locations under the XSport Fitness brand in Chicago, New York, and Virginia. With high build costs potentially slowing topline growth, we could see an increase in M&A activity as fitness operators look for external avenues for growth.

Lowest Rated Issuers Face Refinancing Risk

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Ratings and outlooks across the U.S. fitness sector are currently mixed. However, many issuers remain very highly leveraged and in the 'CCC' rating category as a result of incremental debt issued during the pandemic to finance multiple quarters of cash burn. At this rating level, we expect liquidity management and refinancing risk will drive any rating actions over the next 12 months. For issuers in the 'B' rating category, we expect financial policy regarding mergers and acquisitions, growth, capital spending, and shareholder returns will be the largest factor in assessing ratings upside and downside.

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