As an avid golfer and gear-head I can say from experience that Callaway (ELY) is not the same company it was in the past. In many ways, Callaway became complacent with its position at the top. For much of the last decade, Callaway manufactured the best selling woods, irons, and putters in the game of golf. Callaway consistently earned a profit and had millions of loyal customers. Recently Callaway has stopped marketing aggressively and reduced spending on sponsorship of PGA & LPGA tour players. Many customers no longer find Callaway's equipment exciting or cutting edge. Today Callaway's products lack the cutting edge technology and marketing appeal of its major competitor Taylormade (Adidas AG ADS). In this article I will examine both Callaway's products and financials to prove my investment thesis.
Callaway sprung on to the scene in a major way with the launch of the Big Bertha series woods and irons in the 90's. Not only was the Big Bertha line a commercial success, but it revolutionized golf equipment and afforded Callaway an increasingly loyal customer base. The Big Bertha series was the gold standard for equipment and a cash cow for Callaway for nearly a decade and a half. Callaway stopped manufacturing Big Bertha branded clubs in 2009. Recently the firm has made a series of colossal commercial flops. They spent millions in R&D to develop and market clubs that were discounted heavily before the end of the product cycle to move them from retailer's shelves. Among these flops has been Callaway's I-Mix technology drivers, FT-I series woods, Diablo series woods and FT series irons among others. These flops have alienated both Callaway's loyal customers and retailers.
While Callaway's product line has been weak, primary competitor Taylormade has produced game-changers such as the R9 series woods and irons, R11 woods and irons, and the Burner woods and irons. These successes have propelled Taylormade to the top spot as the #1 manufacturer of drivers, woods, and irons; categories that were in the past dominated by Callaway. Callaway's troubles are two-fold; not only is Callaway earning a smaller share of the market, but the market itself is shrinking. Across the country, participation in the domestic golf market has contracted for the last 3 years.
In recent years, I personally have much preferred offerings from Taylormade and Titleist. A local proshop where I purchase much of my equipment has gone so far as to stop carrying Callaway products. The owner finds them difficult to sell at full price and is therefore left with excess stock when Callaway decides to discount their products at the end of their yearly cycle.
Callaway has not been profitable since 2008. Granted, some of their poor performance can be attributed to disruptions in demand caused by the financial crisis, but a majority of this can be attributed to loss in market share. This was evidenced by the fact that Taylormade recently had the most profitable quarter in company history. Callaway has been unable to cut expenses to cope with falling revenues. Callaway has cut its marketing budget, which made sense on paper as it was a variable expense and Callaway is an established brand. In practice, cutting marketing expenditures was not a wise decision.
Retailers and industry observers, however, maintain that Callaway has continued to make high-performance products, and that its miscues have come more on the marketing front. Aside from insufficient spending, some critics say Callaway's brand messaging in recent years hasn't resonated with consumers. (Golfweek)
These strategic misses by Callaway do not speak well of management.
Pundits may defend Callaway's valuation by pointing to its price to book ratio which stands quite impressively at .79, but a good deal ($230 million of the total $509 million) of Callaway's assets are inventory. In the golf industry, with clubs running on a 1 year products cycle, inventory depreciates at a rate of 50% yearly. Therefore, to get a more accurate picture of Callaway's balance sheet, I find it helpful to factor out inventory. Factoring out inventory, Callaway's price to book returns to a more conservative 1.33.
Callaway bulls may also point to Callaway becoming a possible acquisition target like Adams Golf was to Taylormade/Adidas earlier this year. Since Callaway does still have a fair amount of market share, antitrust laws would likely damper any acquisition by a competing golf company. Additionally, most large sports companies do have golf divisions; Nike (NKE)-Nike Golf, Puma- Cobra, Adidas- Taylormade, Fila- Titleist. A potential takeover by Under Armour (UA) does come to mind, but UA only has cash reserves of 100 Million making an acquisition unlikely. Under Armour is also quite established in the higher margin soft-goods (apparel and accessories) golf industry, so an expansion into less profitable hard-goods (equipment) may seem unattractive.
At this stage, Callaway is not a good investment due to…
- Weak product line and marketing
- Alienation of loyal customers and retailers
- Loss of market share
- Fundamental disruptions in the golf industry
- Increased competition from industry titan Taylormade
- Lack of potential buyers
Callaway does have brand equity and with an overhaul of marketing and the product line, it may one day return to profitability. However, for now, that seems like a costly, time consuming process.