Shares in Ardent Leisure Group (ASX: AAD) are  up 20% after the release of its annual results two weeks ago. While asset sales and the planned expansion of the Main Event franchise fired investor imaginations, today’s prices might be a bit stiff given the company’s likely path over the next couple of years.

Asset sales

The Health Club sale has been finalised, while the Marinas division is still held for sale. Once these two divisions are gone, they’re going to leave a big hole in company earnings – together they accounted for $40 million in segment Earnings Before Interest, Tax, Depreciation, and Amortisation (EBITDA), or 26% of earnings.

The Health Club division is lower margin compared to Marinas and Main Event, but the impact of its departure will be large. Additionally, Ardent has only planned 11 new Main Event centres (current total 27) for 2017, so it could potentially take a couple of years to replace the lost earnings.

If we divide the Main Event segment results by the number of centres, each Main Event centre made an average of $6.47 million in revenue last year and $1.6 million in EBITDA. Using these metrics, 11 new centres in 2017 will add $17.6 million in EBITDA, which is just over half of the health club’s $30 million EBITDA contribution in 2016.

Of course, not each centre will have the same level of success, but that illustrates briefly how there could be a hole left in Ardent’s earnings in the 2017 financial year.

Ardent about Main Event

The funds from the Health Clubs sale and eventual Marinas divestment will be invested into the Main Event franchise, of which management believes the US could support up to 200 locations (current total 27) nationwide. This appears to be a sensible investment given the higher margin and sizeable market opportunity, as well as the long track record of same-centre growth of existing centres.

Yet I was concerned to note a 1.7% decline in same-centre sales in the past year, which management attributes to increasing competition, difficult market conditions, and ‘conscious cannibalisation’ of its own centres in order to maintain market share. Management also deferred interior and exterior renovations to its older centres which may help funds in the short term but doesn’t aid customer patronage.

The bear case

We’ve already seen a big potential hit to earnings from the Health Clubs sale that’ll take more than a year to be recovered by Main Event growth. Investors have also overlooked the fact that Main Event centres seem to need refreshing every five years or so, which is an expensive and time-consuming venture. Expenditure for this purpose will only grow as the Main Event network gets larger.

Additionally, Ardent’s Earnings Per Share are only 10% higher now than they were five years ago (although capital gains have been significant). I like the business and I think its Main Event franchise has potential, especially if it can deliver the same kind of organic growth that its Texan centres have seen so far. Yet I’d prefer to pay a price closer to $2, as I think buyers today are putting money into a capital intensive business targeting fickle leisure consumers, which is not the kind of business to buy at any price.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.