Fitch Ratings has affirmed Pinnacle Bidco's plc (Pure Gym) Long-Term Issuer Default Rating (IDR) at 'B-' with a Stable Outlook.
A full list of rating actions is below.
The 'B-' IDR reflects the group's high leverage, weak fixed charge cover ratios, and negative post-capex free cash flow (FCF), which are balanced by its leading market positions in the UK and Denmark in the value gym segment. Pure Gym's rating is exposed to gradually increasing refinancing risk related to its February 2025 notes maturity, which could lead to negative rating pressure if not addressed 12-15 months before the debt comes due. Its high financial leverage has also been partly offset by materially improved liquidity following a capital raise in January 2022, which we believe should support anticipated debt refinancing.
The Stable Outlook reflects our expectations of continued profit expansion that should enable deleveraging, satisfactory liquidity and capex flexibility, although we incorporate slower expansion than in our previous forecast following slower expansion in 2023. Based on our current rating case, we see limited near-term rating headroom, and would view any deterioration in the group's performance over the next few quarters as negative for the ratings, particularly in light of the upcoming debt maturities.
Key Rating Drivers
Slower EBITDA Growth: We expect slower EBITDA growth to nearly GBP150 million by 2026 than under our previous rating case (over GBP200 million). This is due to a more prudent and halved expansion rate of around 215 new sites addition by 2026. We forecast GBP24 million improvement in EBITDA in 2023, following a strong 1Q23 performance with 12% growth in members yoy in this important period. Fitch-calculated EBITDA of GBP72 million in 2022 is after rents and is not adjusted for certain items that the company includes. Trading in 2H22 was affected by fewer new members in the key September 2022 period.
High leverage: We expect a more gradual reduction in leverage due to slower growth in profits. We forecast EBITDAR gross leverage at 8.5x in 2023, which will exceed the negative sensitivity, reducing to within rating guidelines in 2024. We believe the underlying business is cash-generative and has the potential to deleverage towards 7.0x by 2026 as profits grow due to ramp up of existing sites and new sites start contributing to profits.
Membership Growth: We model growth in memberships to follow a normal cycle with key net addition periods in January and September, rather than expecting post-pandemic recovery for a like-for-like (LFL) portfolio by a certain date. We expect average members per gym in the UK to slightly increase in 2024, then decline due to new gym additions and changes in the site mix, and do not expect it to reach pre-pandemic levels. Pure Gym reported LFL membership count for UK sites (opened before 2018) remained 13% below pre-pandemic level in 1Q23, with revenue now recovered amid improved average revenue per member (ARPM). This is slightly ahead of its closest peer, The Gym Group.
High Refinancing Risk: In our view, refinancing risk is high and will weigh on Pure Gym's rating as maturity of its notes in February 2025 approaches. Our forecast incorporates refinancing at a somewhat higher interest rate than the current around 6% effective interest rate, leading to slightly weaker coverage metrics albeit still aligned with the rating, and a weaker funds from operations (FFO) margin. Refinancing at higher than our modelled rate, which will depend on market conditions and investor appetite, could suppress the margin further and be negative for the rating.
Low Cost Business: We anticipate the EBITDAR margin will recover to 40% by 2025, instead of 43% previously, due to slower growth and somewhat lower average members per site. The low-cost business model with caps and collars on rents and forward contract on energy partially protect the group from cost inflation eroding profitability.
Execution Risk in Expansion: Our rating case sees some execution risk associated with around new 190 gym openings assumed for 2023-2026 in the UK. We see a risk of over-expansion in the sector, especially if other gym operators follow suit, even if demand trends appear favourable for expansion. This is somewhat mitigated by weakened competition post-pandemic and Pure Gym's record of opening and ramping up new sites. We incorporate increased average capex per site of around GBP1.2 million.
Value Offering: Fitch expects Pure Gym's value business model to perform better in a recessionary environment than traditional peers. This is because its monthly fees are materially lower than traditional private operators and Pure Gym has no membership contracts with notice periods. Fitch believes this provides Pure Gym with a competitive advantage as consumers seek lower-cost propositions. The business model is strengthened by Pure Gym's variable pricing model, which allows flexibility for margin preservation while competing with local peers.
Growing Value-Gym Market: The IDR reflects Pure Gym's leading position in the value-gym market, which we expect to continue to grow. We believe the group is well-positioned to benefit from a renewed focus on health & wellbeing trends post-pandemic.
Derivation Summary
Pure Gym generally operates on higher EBITDAR margins than the median for Fitch-rated gym operators, including those within its food, non-food retail and leisure credit opinion portfolios, due to its scale and a value/low-cost business model. However, due to its accelerated expansion programme and slower member growth, we do not expect Pure Gym's profitability to exceed the industry average over our forecast period. Pure Gym has been taking market share mainly from its mid-market peers, due to the competitive nature of its pricing structure.
We view Pure Gym's forecast total adjusted debt/ operating EBITDAR at 7.8x by end-2024 as high, but in line with that of similar leisure credits in the low 'B' rating category. Negative FCF amid an expansion strategy restricts the IDR. However, Pure Gym's cash flow conversion and deleveraging capability is structurally better than for high-street retailers, and is now further enhanced by equity-funded capex.
Pure Gym is rated one notch below its closest Fitch-rated peer, Deuce Midco Limited (David Lloyd Leisure, DLL; B/Stable), the premium lifestyle club operator. Pure Gym has a more aggressive expansion strategy, which carries higher execution risk than for DLL, resulting in expected weaker FCF generation and higher leverage. Following the accelerated expansion to be funded by equity injection, we expect Pure Gym's leverage to reach around 7.0x by 2026, three years later than DLL under its capital structure.
Pure Gym has mildly higher profitability than DLL with EBITDAR margin trending towards 41% due to its low-cost business model, versus around 37% at DLL.
Key Assumptions
Fitch's Key Assumptions within our Rating Case for the Issuer:
Average memberships for 2023 at around 1.8 million (11% higher than average 2022 levels) and gradually increasing to 2.3 million by 2026, benefitting from new gym openings and the ramp-up of new gyms
Around 40 corporate-owned new gym openings in 2023, followed by around 175 new gyms in 2024-2026 (50 in 2024, 55 in 2025, and 70 in 2026) and 27 gym closures between 2023 and 2026 in Denmark
Average members per gym post-2023 gradually declining to reflect the ramp-up of new gym openings and smaller format boxes with lower capacities
ARPM gradually increasing to GBP24.6 by 2026 from GBP23.7 in 2022
Sales CAGR of 9% in 2023-2026, supported by increasing ARPM, new site openings and the ramp-up of new sites
EBITDAR margin recovering to around 38.6% by 2023, and gradually nearing 41% by 2026, supported by increase in scale, maturation of newly-opened gyms, margin improvement efforts in Denmark and contribution from franchise sites
Fitch-derived EBITDA includes a GBP9 million negative impact from of our lease treatment against cash lease cost (lease costs calculated as the sum of right-of-use asset depreciation and P&L interest cost; the difference for the forecast period of 2023-2026 is expected to narrow)
Average capex at around GBP115 million per year between 2023 and 2026 to fund new site openings and refurbishment projects
No dividends and no acquisitions to 2026
Key Recovery Rating Assumptions: The recovery analysis assumes that Pure Gym would be reorganised as a going-concern (GC) in bankruptcy rather than liquidated. We have assumed a 10% administrative claim.
The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon which we base the valuation of the group.
Pure Gym's GC EBITDA of GBP110 million is based on Fitch-projected EBITDA in 2024, reflecting the ramp up of existing sites as well as contribution from new site openings by 2024. This reflects competitive dynamics, which are partly offset by a broadly resilient format given its lower price point but lack of contracts.
The current Fitch-distressed enterprise value (EV)/EBITDA multiples for other gym operators in the 'B' rating category have been around 5x-6x. Fitch recognises that Pure Gym has a leading share in the growing value-gym market, which justifies a 5.5x multiple, although Pure Gym currently does not have any unique characteristics that would allow for a higher multiple, such as a significant unique brand, material franchise revenue or undervalued real-estate assets.
The GBP145 million RCF, which ranks super-senior to the senior secured notes, is assumed to be fully drawn upon default.
After deducting 10% for administrative claims, our principal waterfall analysis generates a ranked recovery for the senior secured debt, in the 'RR4' category, leading to a 'B-' rating for the bonds. The waterfall analysis output percentage based on current metrics and assumptions is 47% (unchanged).
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade (to B):
Growth in membership numbers and revenue from mature sites and maturing new sites, while continuing to control cost, leading to:
- (Fitch-defined EBITDA minus interest and operational cash expenses)/revenue (previously known as FFO margin) trending to 10%
EBITDAR fixed charge coverage above 1.5x on a sustained basis
Total EBITDAR leverage below 7.5x
Factors that could, individually or collectively, lead to negative rating action/downgrade (to CCC+):
Lack of progress on refinancing 12-15 months before material debt maturities or refinancing at materially higher interest rates, leading to EBITDAR fixed charge coverage below 1.2x
Loss of revenue and decline in profitability due to economic weakness, increased competition and pressure on pricing leading to (Fitch defined EBITDA minus interest and operational cash expenses) / revenue (previously known as FFO margin) consistently below 10%
Total EBITDAR leverage remaining above 8.0x on a sustained basis
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Comfortable Liquidity: Following the GBP300 million equity injection in January 2022, we view Pure Gym's liquidity as comfortable, supported by GBP235 million cash on sheet balance (of which GBP30 million is held at the parent entity) at end-2022 and full availability under the GBP145 million RCF. We expect that cash on hand including the proceeds from the equity injection together with internally generated cash flows will be more than sufficient to fund Pure Gym's accelerated expansion strategy in 2023-2024.
We project FCF to stay negative, driven by higher capex needs related to the number of gym openings and gym refurbishments and despite EBITDA expansion on new gym openings and the maturation of newly-opened gyms.
The group has extended the maturity of the RCF to January 2025, similar to that of the existing GBP430 million and EUR490 million senior secured notes due in February 2025.
Issuer Profile
Pure Gym is a leading low-cost gym operator in Europe with around 560 sites across UK, Denmark and Switzerland (as of March 2023).
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
THE GYM GROUP PLC 
