Travel Isn’t Back, But Golf Is, And That’s Bullish For This Respected Brand

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As summer approaches, and the weather is improving across the United States and much of the rest of the Northern Hemisphere, people are itching to get outside.

Months of quarantine and social distancing have been difficult, and for many, the change in the seasons is making it that much more difficult to remain cooped up indoors. 

However, this summer will not be the summer that many had planned.

With the threat of coronavirus still lingering and with strict travel restrictions in place, many travel plans have been cancelled. Parents can no longer take advantage of lengthy school breaks to take the family on a beach vacation to the Caribbean. Flying to Italy or Spain for a European vacation seems unlikely. Those looking to catch the 2020 Olympic Games in Tokyo are going to have to look elsewhere for their sports entertainment.

With traditional vacation plans likely on the back burner, consumers are going to start to look for adequate, safe, and outdoor, alternatives.

Due to social distancing mandates, options are more limited than before the pandemic, but certain industries should be able to service this demand. As a result, some companies stand to benefit tremendously from this tailwind.

An Activity Industry Built for Social Distancing

By mid-May, all states had reopened their golf courses in at least a limited capacity. With large courses, open space, and individual equipment, golf is an activity that fits well in a world of social distancing and heightened sanitation concerns.

However, the stock market has not seemed to recognize the potential for firms focused on this space.

Callaway Golf Company
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, the #1 manufacturer of golf-related hardgoods in the United States and Europe, has seen its stock price fall by over 28% since the beginning of the year. By contrast, the S&P 500 has fallen by just 7%.

Given this steep decline, Callaway should pique the interest of investors looking for value in a downtrodden market.

However, before making any decision about a company’s valuation, it’s vital that investors understand exactly what market expectations are for future performance. Without an understanding of the market’s position on a stock, it’s impossible to know if one thesis is completely different than others, or if it’s in lockstep with the rest of the market. One can understand this by looking at the market’s embedded expectations for future performance at a company’s current valuations.

When Uniform Accounting metrics are applied, the distortions from as-reported GAAP accounting statements are removed – including the impact of non-cash stock option expense that Callaway uses as a management incentive and goodwill, a purely account-based measurement of acquired assets, which is not representative of operating performance.

By cutting out the “noise” of as-reported accounting, one can back into the future levels of Uniform ROA and asset growth the market expects at current stock prices and valuations. The embedded expectations chart below shows Callaway’s historical corporate performance levels in terms of Uniform ROA and asset growth (dark blue bars) versus what sell-side analysts think the company is going to do for its next fiscal year and fiscal year 2021 (light blue bars) and what the market is pricing in at current valuations (white bars).

At current valuations, markets are pricing in expectations for profitability to collapse from 14% in 2019 to just 8% going forward, accompanied by modest 6% Uniform asset growth. This suggests the firm will lose all its recent improvements from emphasizing its apparel and gear segment and expanding into new geographies.

The market may have this pessimistic view in part because as-reported GAAP-based metrics incorrectly show Callaway to be a weaker return business.  But using Uniform Accounting we can see through this noise to understand how mis-priced expectations are.

Meanwhile, analysts appear to see through this noise and have less bearish expectations, projecting Uniform ROA to rebound significantly after falling to 7% in 2020 as the firm successfully navigates current coronavirus-related headwinds.

Callaway Stock Has the Potential to Launch Forward

Investors appear spooked because of the impact of coronavirus and related supply chain disruptions on the firm’s operations. In addition, they may be concerned that the firm may face sell-in issues as its retail customers work through unsold inventory.

Ultimately, these are largely transitory issues, and expectations for the firm to see a permanent profitability decline going forward seem overly bearish. Management has actively acknowledged the potential impact of these headwinds and has already taken steps to mitigate their impact.

The firm has materially reduced its operating expenses and capex. It has worked to minimize its inventory commitments. It has also increased its liquidity to service near-term obligations through the drawdown of revolving credit facilities.

The market is also underappreciating the numerous tailwinds Callaway has.

First, the firm’s geographic expansion and diversity has helped to limit risk and increase growth opportunities. Particularly, the firm’s expansion into Asian markets has proven to be accretive. In fact, even in Q1, in the midst of the coronavirus outbreak in Asia, Callaway’s revenue in Japan and Korea actually grew. 

Since Asia was hit by the pandemic earliest, and since these countries were swift to act, the impact of the coronavirus in the second quarter is likely lesser than in the United States, lifting Callaway’s performance.

Second, the firm’s increased focus on golf and other sport accessories and clothing, through acquisitions such as travisMathew in 2017 and JACK WOLFSKIN in 2019, has allowed it to expand its e-commerce presence, which has exceeded expectations in recent quarters. This new sales channel should prove to be more resistant to coronavirus headwinds and also provide for growth opportunities in the long-run.

Lastly, Callaway’s primary end consumers are, as the firm states, “well capitalized”. In other words, they tend to be wealthy. As such, many of its customers still have the ability to spend on discretionary items. Instead of allocating this money to a vacation, as some may have before, they might be more inclined to splurge on golf gear.

The Bottom-Line

At current levels, markets are pricing in expectations for Callaway to see a significant profitability collapse, which suggests transitory coronavirus-driven headwinds would persist indefinitely. The market seems to be missing the firm’s potential growth drivers, including geographical expansion, increased e-commerce opportunities, and a well-capitalized client base eager to spend. 

If the firm were to just meet analyst projections, which entails a profitability decline in 2020, followed by a swift rebound, long-term equity upside may be warranted for Callaway. If analyst estimates are overly pessimistic, considering the tailwinds discussed, there could be significantly more upside.

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