We’re approaching Memorial Day in the United States, which means it’s almost summer. One activity that many people around the world will be participating in this summer is golf. The sport has surged in popularity during the pandemic – it’s easy to socially distance on the course – and is benefiting gear and apparel sellers Callaway (el 0.30%).
But Topgolf, which Callaway acquired in 2021, fared poorly in the earlier stages of the pandemic as social distancing efforts and a drop in in-person events impacted visitor traffic at its high-tech golf entertainment complexes. Heading into the summer of 2022, Topgolf is recovering well from its pandemic slump.
Still, Callaway’s stock is down 28% year to date. Does that mean it’s a good time to buy stocks?
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Strong sales of gear and apparel
Callaway reported its Q1 results on May 10th. Golf equipment sales increased 24.2% year over year to $468 million. This is the legacy business, which includes Callaway’s branded golf clubs and balls and Odyssey putters. The business is growing well and is Callaway’s most profitable segment with operating income of $101 million in the most recent quarter, or an operating margin of 21.5%. Don’t expect this business to grow rapidly every year, but it should be a good source of cash to fund management’s growth ambitions for Topgolf.
The Clothing and Equipment operating segment also showed strong growth. Net sales increased an impressive 37.4% year over year to $250 million with an operating margin of 11%. The segment is home to fashion brands Travis Matthew, Ogio, Jack Wolfskin and Callaway. Of these, Travis Mathew is the most notable, with its retail businesses posting phenomenal 50% same-store sales growth in the first quarter. It also just launched a women’s clothing line to expand its addressable market.
Callaway is making solid growth and profits from equipment and apparel, but it’s the company’s third segment that will drive most of its growth over the next decade: Topgolf.
Growth will come from Topgolf
Callaway acquired the golf entertainment and technology company for $2.66 billion last year (not including the portion of the business that Callaway already owned). Topgolf operates large driving range venues that sell quality food and beverages and provide catering for group events and parties. It also features the Toptracer technology used by the PGA Tour and licensed to driving ranges across the country for an annual fee.
For the first quarter, Topgolf’s pro forma revenue was $322 million, compared to $236 million for the same period last year. The segment was barely profitable with an operating margin of 2%, but that’s because it’s still investing heavily in growth and recovering from the impact of the pandemic. However, there are good signs that business is picking up steam again. Same-location sales increased 2.3% for the quarter compared to the same period in 2019.
Longer term, Callaway plans to grow Topgolf by opening approximately 10 new locations per year and driving co-location sales growth. With fewer than 100 venues around the world, the company should be able to add locations at this rate for at least the next decade without reaching market saturation. This could help Topgolf’s sales grow at double-digit rates for many years to come.
What about the rating?
As of this writing, Callaway has a market cap of $4 billion. Adding net debt of $1.71 billion brings enterprise value (EV) to $5.71 billion. There are a few ways to evaluate Topgolf’s business. First, we can look at the 2022 Adjusted EBITDA range of $535 million to $555 million. Based on the midpoint of that range, the stock trades at a 2022 adjusted enterprise value-to-earnings (EV/E) ratio of 10.5. This seems pretty cheap on an absolute basis.
But there’s more to the Callaway story. The company is investing hundreds of millions in Topgolf — an estimated $230 million this year alone — and expanding locations across the United States. This will reduce the company’s consolidated free cash flow for many years to come, making it difficult for the company to return cash to shareholders via dividends or share buybacks. That’s not to say investors won’t see value from the returns Callaway will generate on that invested capital, but some of that will be delayed.
All in all, now could be a good time to buy Callaway stock given how cheap the expected earnings multiple is. However, they must be confident in Topgolf’s long-term growth and profitability prospects.
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