Introduction to Callaway Golf
Callaway Golf is a global sporting company that designs, manufactures, markets and sells golf equipment, gears, apparel and accessories. Since its public market debut in 1992, Callaway Golf has evolved from a golf club manufacturer to a leading distributor and manufacturer of premium golf equipment and accessories.
In recent years, Callaway Golf has undertook a new strategic direction in an effort to diversify and grow its business. Here’s a breakdown of its acquisitions since 2017
- Jan 2017: Acquisition of OGIO International, a leading manufacturer and distributor of premium storage gear for sports.
- Aug 2017: Acquisition of TravisMatthew, a leading designer and distributor of premium golf and lifestyle apparel, gear and accessories.
- Jan 2019: Acquisition of Jack Wolfskin, a premium outdoor apparel, footwear and equipment brand
With its recent acquisitions, the company is focused on integration and realizing cost and revenue synergies. The aim is to create a diversified global business platform while investing strategically in areas complementary to golf.
The golf market at a glance
According to National Golf Foundation, golf is an $84 billion industry and remains the no.1 outdoor pay-for-play individual participation sports in the US.
Despite this, the golf club markets are highly competitive and are served by a number of well-established and well-financed companies with recognized brand names. These include TaylorMade, Ping, Acushnet (Titleist brand), Puma (Cobra brand), SRI Sports Limited (Cleveland and Srixon brands), Mizuno, Bridgestone, and Parsons Xtreme Golf (PXG).
Similarly, the golf ball segment is equally competitive with Acushnet (Titleist and Pinnacle brand) commanding ~50% market share globally.
All in all, while not the market leader, Callaway Golf remains a top 3 market share leader in most categories. The company continues to be regarded as a leader in technology and innovation in its field.
How does Callaway Golf make money?
Callaway Golf makes money through selling golf equipment (clubs and balls), gears, apparels and accessories. Its main expenses are cost of raw materials, R&D and distribution & marketing.
Geographically, Callaway Golf generates 46% of its revenue from the US, 25% from Europe, 14% from Japan and 14% from the rest of the world. Arguably, the regional exposure has been fairly stable over the years.
Understanding Callaway Golf
Robust financial position
Callaway Golf is in good financial health. A low and declining debtor/sales ratio highlights the company’s efficiency in collecting revenue. Its creditor/cost of sales is also fairly robust at 7% in 2019. While a higher ratio is more favorable to the company, we argue that this gives them room to delay payments to suppliers if required, although there is no reason to suggest why they would need to. Inventory/sales ratio also remain stable over the past decade, with an average of 26%.
Last but not least, robust free cash flow conversion. Since its growth plans in 2015/16, FCF conversion continues to creep up, which is always a good sign.
One of the reasons we like the stock is because of the optionality of its stake in Topgolf. Callaway Golf currently owns 14% of Topgolf.
While the pandemic has deflated its valuation, we guesstimate the stake to be worth somewhere between $360-390 million. The proceeds can be used to further diversify its earnings, corporate purposes or to pursue further growth inorganically.
Slow but steady growth and margin expansion story
After years of underperformance, the management team has successfully executed a turnaround to reinvigorate the Callaway Golf brand. The pivot to a growth strategy in a consolidating industry is welcoming. Consequently, we’re confident that the Group will emerge as a winner.
First, the brand refresh of Callaway Golf’s franchise over the years has begun to pay off. This is evident through its increased market share, accompanied with both volume (partly driven by acquisitions) and margin expansion.
Secondly, its diversification through acquisitions. The company has completed four acquisitions since 2016, pivoting themselves into the higher margin premium active lifestyle segment.
Despite the acquisitions, our forecast indicates that the bulk of its synergies have not come through completely and should expect further cost savings post integration. We hypothesize a lower cost of equity (lower perceived risk) in the medium term given its diversification, benefiting its valuation.
Finally, Callaway Golf’s commitment to innovation and growth remains the key driver for the company. It has consistently plough back profit into R&D, amounting to ~$390 million from 2009-2019. From balls and putters to wedges and drivers, the results were higher quality products manufactured with cutting-edge technologies. The Big Bertha driver is an excellent example. Accordingly, this is also why it experienced margin expansion despite a highly competitive market.
Significant insider ownership
As a rule of thumb, for company of this size, we would expect at least 1.5% of insider ownership.
The latest proxy filing described an insider ownership of ~2.2%, with the CEO owning just under 1.4%. With limited insider selling since despite stock options vesting, we have reasons to believe that the management’s incentives are aligned with shareholders’.
Key risk to Callaway Golf stock
The elephant in the room is clearly the Covid-19 crisis. While wholesale sales of clubs were up over 30% year-on-year in June, we remain very cautious on its growth outlook in the coming months, especially with the second-wave of coronavirus taking center stage.
Second, its FX and hedging risk. The company derives >50% of its sales outside the US, which means that its revenue is at the mercy of the US Dollar. The company does, however, employ a hedging strategy to partially neutralize the impact of FX to a certain extent. In general, a weaker US Dollar is favorable to the Group.
Lastly, the lack of operational synergies could be a key risk. As for all acquisitions, there is always uncertainty in realizing synergies. While we see this as a low risk scenario, the impact of expanding coronavirus has certainly made it more challenging to do so.
Callaway Golf financials
Here’s a snapshot of Callaway Golf financials.
Callaway Golf valuation
We consider the three key groups: golf equipment, athletic and leisure as Callaway Golf’s comparables. In computing our “Synthetic” valuation, we assume 60% golf, 25% athletic and 10% leisure, using the 2019 revenue split as a reference. In summary, we find the Callaway Golf’s valuation reasonable relative to its peers. A lower profitability, but accompanied with a lower valuation. However, the lack of dividends and continuous low profitability vs peers introduce some form of uncertainty for long term investors like us.
Why are we waiting to invest in Callaway Golf?
Callaway Golf has a sound business plan to grow the business in the medium term. Led by an experienced management team with significant stock ownership, the Group is now focus on investing strategically in areas complementary to golf, with the focus of establishing synergies and realizing efficiencies across the all brands.
A fantastic franchise and a leader in advanced golf technology, we believe these will continue to propel the business forward. In addition, the optionality in Topgolf creates a unique proposition not only for the Group but also potential investors.
Now, the big question is whether we would be adding to our portfolio today. We’re in a bit of dilemma, since we like the prospect of the business, but are cautious on its valuation. Here’s why.
First, we think the lack of dividend is an issue for long term investors like us. It pays a regular quarterly dividend of $0.01 per share, which is arguably non-existent. Furthermore, we know from our previous article that statistically non-dividend payers tend to underperform its peers.
Moreover, the Group has not paid a meaningful dividend for more than a decade. With its current acquisition strategy, we can really bid goodbye to proper dividend for the foreseeable future.
Secondly, somewhat underwhelming profitability. While we acknowledge it is cheaper vs its synthetic valuation, we believe that the profitability can be further improved. We would be looking for further evidence that its acquisitions can bring about improved profitability and cost efficiencies.
In short, we like the stock, but not the price. All else being equal, we would be interested to add the stock should it trade around $16, which is 15% below where it trades currently. In the world of golf stocks, we shall follow the quote of World Golf Hall of Famer Gary Player.
“A good golfer has the determination to win and the patience to wait for the breaks.” – Gary Player