In a declining market, multiple strategies can be employed to generate alpha. One of the most popular strategies is to buy undervalued quality stocks or high-growth stocks at a discount to fair value.
The one drawdown of this strategy is that it can take time to see positive results. Plus, depending on one’s patience level before initiating purchases, it is very susceptible to drawdowns, with investors fighting momentum.
A strategy that I prefer to use in cyclical bear markets (like we’ve found ourselves in) is to look for stocks that have given up ground grudgingly vs. the general market but also have industry-leading growth metrics.
Often, these stocks are the new leaders in the next bull market cycle, but this is not yet obvious given that they’re being held back by the weight of the general market, similar to a beachball being held underwater.
When the weight of the market finally does come off, these stocks can put up triple-digit returns in a short period.
However, and most importantly, even if the market continues to decline, these stocks typically hold up much better. This is because they have already proven they can swing against the tide, evidenced by being in uptrends while the market itself is making lower highs and lower lows.
One name in the leisure-services industry group fits this criterion, making it a name worth placing at the top of one’s watchlist.
Strong Technical Picture And Explosive Growth
Xponential Fitness (XPOF) is a $900MM market cap stock in the leisure-services industry, an industry group many might prefer to shy away from after Peloton’s disastrous past year.
However, it’s important to note that while leisure businesses and leisure stocks can be high risk, Xponential Fitness is cut from a different mold than capital-intensive Peloton, being the largest global franchisor of boutique fitness brands.
Its ten brands span all areas, including pilates, yoga, boxing, cycling, rowing, and functional training, with brands including Club Pilates, CycleBar, StretchLab, Row House, and Rumble.
While concentrated in North America, its 2,300+ studios are in 12 countries, and it has licenses awarded for over 4,500 studios to date.
However, the company has barely scratched the surface. This is because it’s in the growing $22BB Boutique Fitness market (5.5% CAGR).
This is much more attractive than Planet Fitness’s (PLNT) model, which has bigger box sizes (more square footage) and lower membership fees.
Notably, the company’s COO plus CEO boasts a combined 45 years of industry experience and previously worked at UFC, Club Pilates, and 24-Hour Fitness.
During the company’s most recent quarter, it reported revenue of $59.6MM, translating to 66% growth year-over-year. This was despite lapping 67% growth in the year-ago period, translating to a two-year average revenue growth rate that’s higher than 90% of publicly traded stocks on the US Market.
The solid revenue growth metrics were driven by robust franchise license sales (251 sold in Q2 2022) and the opening of 128 new studios.
This torrid pace of franchise sales can be attributed to the growing average unit volumes at its studios, a critical indicator for the health of a franchise model that helps investors understand the overall economics that would entice prospective investors to purchase franchises.
During Q2, average unit volumes increased to $480,000 vs. $384,000 in North America, a phenomenal figure considering that studios have an initial investment of $350,000 and ~30% operating margins, translating to a less than 3-year payback.
These solid results prompted Xponential to raise full-year guidance, expecting 39% revenue growth for the full year vs. an outlook of 33% previously.
In addition, it expects to open over 500 studios, translating to more than 50% growth vs. FY2021.
Finally, while it reported negative quarterly earnings per share in Q2 2022, it expects to finish the year with positive annual EPS of $0.34 before growing annual EPS by more than 250% in FY2023 ($1.21 vs. $0.34), giving it one of the highest-earnings growth rates on the US Market.
The Fundamental Case
Based on annual EPS estimates of $0.34 in FY2022 and a share price of $18.60, Xponential trades at a premium to its peer group, sitting at 54x current earnings estimates vs. Planet Fitness at 41x earnings.
However, from a 1-year forward annual EPS standpoint, Xponential is dirt-cheap, trading at just ~15x FY2023 earnings estimates vs. Planet Fitness at 30x FY2023 earnings estimates.
Given that XPOF has much higher growth, this makes this discount even more attractive. Besides, even if we assume a more conservative earnings growth rate of 30% long-term, Xponential trades at a forward PEG ratio of just 0.51.
The Technical Setup
From a technical standpoint, it’s hard to find a better-looking stock, with XPOF gapping up following Q2 earnings on 4x average volume and consolidating over the past two weeks while the S&P-500 gave up considerable ground.
The stock also trades above a rising 10-day, 20-day, and 50-day moving average, meaning that momentum is at its back.
Finally, the stock made a new 10-day high last week, even during a week when the overall markets plunged.
This suggests it may be ready to break out of its short-term base if the markets can cooperate this month, potentially sending it north of $25.00 later this year (next resistance area).
Meanwhile, it’s likely to hold the $17.60 level even if we do see further market weakness, giving it a very attractive reward/risk ratio.
The Bottom Line
Based on FY2023 annual EPS estimates of $1.21 and what I believe to be a conservative earrings multiple of 25, I see a fair value for XPOF of $30.25.
This translates to more than 60% upside from current levels, making this a small-cap worth paying close attention to for those looking to add growth to their portfolio.
To summarize, I see XPOF as one of the better-positioned growth stocks in the current market due to its strong technical picture and explosive growth. I would view any weakness as a buying opportunity.
Disclosure: I am long XPOF
The above analysis of Xponential Fitness (XPOF) was provided by financial writer Taylor Dart. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Is Xponential Fitness (XPOF) A Buy or Sell?
Based on MarketClub’s technical analysis tools, Xponential Fitness (XPOF) is showing signs of short-term weakness, but still remains in the confines of a long-term uptrend. Keep an eye on XPOF as it may be in the beginning stages of a reversal.
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