Thursday, March 19, 2020

A Current AIM Small Cap Equity Holding: Callaway Golf Company (ELY, $18.78) "With Bunkers Down the Fairway, Callaway Looks to Follow-Through"

 Callaway Golf Company (ELY, $18.78) "With Bunkers Down the Fairway, Callaway Looks to Follow-Through" 

By: Ellie O’Donoghue, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.


Callaway Golf Company (NYSE: ELY) is an American sporting goods company that designs, manufactures, and sells golf clubs, golf balls, and other golf-related accessories.

•ELY has three operating and reportable segments: Golf Clubs (57.8% of FY18 revenues), Golf Balls and Gear (15.7%), Accessories and Others (26.5%).

• Callaway Golf Company sells its products throughout the United States and about 100 countries under the Callaway Golf, Odyssey, Strata, OGIO, and TravisMathew brand names

• Management has indicated a focus on continuing to invest in R&D resources, especially AI, as well as tour and customer-facing initiatives, such as fitting capabilities and B2B systems.

• Callaway is facing significant financial headwinds in 2020 due to coronavirus, unfavorable foreign exchange rates and tariffs.

Key points:
Through their strong brand position and continued investments, Callaway Golf Company’s valuable internal restructuring and operational improvement has led it to maintain market leadership in the stable worldwide golf market. In their recent 2019 earnings call on February 10th, Callaway’s management announced a strong overall fiscal year, with a few missed figures in the fourth quarter due to some macro and industry headwinds. As a whole, management stated that due to a fiscal year filled with strategic and tactical reinvestments alongside overall positive market condition, Callaway saw a 7.3% increase in revenues in the golf equipment segment and overall revenue growth in every market.

With 2019 being a year of reaping the benefits from expanding product launches and reinvesting in product technology and development, Callaway continues to be able to claim the number one market share position in clubs in both the US and Europe.  Callaway has invested over $110MM in the past three years to create and modify product designs using computer aided design software, finite element analysis (“FEA”) software and structural optimization techniques through Artificial Intelligence methods. New product innovation combined with press coverage of using never before seen AI technology has increased historically flat performance up 1% with estimates of new product launches helping a net sales growth 56% in 2019.

In addition to these new and improved product launches, Callaway has been aggressively reinvesting in their 700,000 square foot Callaway’s Chicopee ball plant capital project in Texas in order to consolidate their DC’s in Japan, China and the UK.  Although Callaway has seen a relatively strong year of operational and financial performance, Callaway faces some sizable headwinds due to coronavirus, unfavorable foreign exchange rates and tariffs that will have a significant impact on their financial results. The most notable factor is the coronavirus outbreak, which will affect Callaway’s sales in Asia and their supply side overall. The coronavirus is already making a clear impact, with Callaway forecasting a $25 million revenue decline two days after their relatively positive 2019 earnings call. Management’s statements on the sizable headwinds they are facing had a significant impact on their stock price, with shares sliding 8.5% the day they announced their expectations on the impact coronavirus will have on disrupting their manufacturing. Although management is still positive on 2020 and their ability and commitment to make successful long-term investments, Callaway’s fiscal year success will be dependent on the viral outbreak and its effects.

What has the stock done lately?
Although having a strong past year performance, the rise and intensity of the coronavirus has adversely affected the stock price. ELY has decreased 11.42% in the past quarter and their decrease in price is not showing signs of slowing down due to the continued prevalence of their dependence on China. Callaway’s price range of $14.49-$22.33 shows the impact that the virus has had on the company, with the biggest impacts being seen after the company announced their forecasted revenue decline on February 12th, with Callaway Golf’s shares seeing an immediate decrease of 8.5%. Although the coronavirus will certainly have an impact on Callaway’s supply chain and near-term demand for their products in China, management is still positive on 2020 being a year of “above-average reinvestment” and hopes to see these investments be reflected in the stock price once the coronavirus epidemic is, hopefully, resolved.

Past Year Performance:
For their full-year 2019, Callaway’s revenues increased 37% to $1.7 billion due to strong performance in their golf equipment sales alongside gains in their soft-goods sector including their brand TravisMathew and $356 million in Jack Wolfskin sales. Callaway reported earnings of $79 million for the year, with a 36.87% growth seen in sales. With the headwinds Callaway is expecting, management still expects full-year sales of $1.75 to $1.78 billion due to their reinvestment focus.

My Takeaway
Although facing some macro factors that will have an impact on their financial results, I believe ELY still has the opportunity to make the put and thus should remain in the AIM small-cap portfolio. Since being added to the portfolio at a price of $15, ELY has proved itself to be a great swing due to their focus on transformation including considerable amounts spent in R&D, new strategic acquisitions and reinvestments in existing business to drive growth. Although facing bunkers ahead, Callaway’s strong brand position and continued investments in current and potential product portfolio has the ability to out-last the potential short-term effects of coronavirus and other macro headwinds they are working on mitigating in 2020. With an original target price of $25, playing the golf-game slow and steady will eventually ring true by the end of the year, and Callaway has the potential to recover and make a hole-in-one by the end of the year.

Source: FactSet