Callaway Golf (ELY) has historically been a market leader in the golf equipment manufacturing industry, largely without the use of expensive marketing campaigns. Although competitors like Nike (NKE) have consistently attracted attention with advertising juggernauts like Tiger Woods among its marquee clientele, the emphasis on quality, design innovation, and the brand’s popularity among a broader spectrum of elite professional golfers, has solidified Callaway’s foothold as one of the top two in terms of market share in almost every equipment category.
The recession had a tremendous impact on the golfing industry as a whole, with rounds played having diminished considerably in the United States over the past three years (down about 12% in 2009 alone). However, despite the downturn in the economy, Callaway boosted earnings in 2007 and 2008. Although the company’s bottom line fell into the red in 2009 (along with most of its competitors), the solid showing in the prior two years demonstrates the company’s earnings power even when the sport and its related retail industry is out of favor. Much of this momentum stems from the company’s reliance on brand loyalty and the prestige of a premium brand. A focus on research and development in technological enhancements also has helped to propel revenues.
However, in recent years other high-end gear manufacturers, such as Titleist, which is owned by a subsidiary of Fortune Brands (FO), TaylorMade, owned by Adidas, and Ping have been closing the performance gap. This intensified competition has resulted in product life cycles of two years or less. Indeed, in the retail golf equipment market, a huge chunk of total revenue is generated by products that are in their first year of distribution. In fact, once the hype dies down surrounding a new release, it is commonplace for demand, along with volume and profit margins, to decline substantially. Moreover, although the economy is recovering and consumer confidence has improved, the market for Callaway’s premium products declined further in 2009. It is likely that the U.S. golfer will opt for discounted models this year in order to save money. This may create some challenges for the company’s top- and bottom-lines.
Still, Callaway’s management is taking the shift in industry dynamics in stride. It is identifying markets where golf is rapidly growing in popularity and demand is on the rise in an attempt to cultivate its business in areas that can drive future performance. Indeed, with the U.S. in recovery and Europe embroiled in economic turmoil, the company is looking to emerging markets for untapped growth potential. Asia is one such region, as participation in the sport is growing at an annual rate of about 15%. Management acknowledges that in order to penetrate these markets successfully, it will have to adapt its business model to adopt a more media-driven, celebrity endorsement approach.
In India, Callaway has inked a deal with, perhaps, the country’s most renowned golfer, Jeev Milkha Singh, to be the company’s brand ambassador. Entry into this market appears timely given the surge in the number of players, rounds played, and golf courses in that country. There are approximately half a million golfers and roughly 250 courses in India, up from about 80 in 2005.
Furthermore, the company’s international management team notes that non-U.S. markets account for roughly 50% of Callaway’s sales. Population alone is a considerably appealing factor in Asia. Better still, are the improvements in the standard of living, the increases in purchasing power, and the rising number of people interested in discretionary spending on leisure activities, particularly golf, which is often linked to informal deal-making in the corporate world.
Taking the aforementioned factors into account, we view Callaway Golf shares as an exciting play in the recreation space. The company has no long-term debt and has implemented several cost-efficiency measures to propel margin expansion. We look for sales and earnings to recover rapidly over the next 3 to 5 years on the strength of notable brand recognition and a market leading position in almost every equipment category. Moreover, the planned foray into emerging markets is likely to be a solid growth catalyst.