The S&P 500 index and Nasdaq Composite are up around 17% and 34%, respectively, this year. Whether it's truly the start of a new bull market or not, it's time to consider adding companies to your portfolio that could deliver great returns as the economic outlook improves. One promising growth stock to consider is Top Callaway Brands (MODG -0.81%).
Callaway is an iconic golf equipment brand, but the company has been expanding beyond hardcore golfers to bring new people to the sport. In 2021, Callaway merged with Topgolf, a leading off-course golf entertainment business with more than 80 owned and operated venues. Topgolf now makes up nearly 40% of the company's revenue.
Even before the acquisition of Topgolf, the stock was a strong performer for investors, nearly tripling in value between 2015 and 2021, but the recent sell-off could be a great buying opportunity. Here are three reasons the stock could see more gains in the next bull market.
1. Strong growth in challenging environment
The first thing that jumps out about this company is its strong growth last year amid a choppy consumer spending environment. Topgolf Callaway reported robust revenue growth of 27% in 2022. Even after adjusting for the effect of the acquisition of Topgolf in 2021, revenue would still have been an impressive 22%.
However, revenue growth slowed to 12% year over year in the first quarter of 2023. This was due to lower sales in golf equipment, as Topgolf and active lifestyle (apparel and accessories) remained strong.
| Segment | First Quarter 2023 | YoY Change |
|---|---|---|
| Topgolf | $404 million | 25% |
| Golf equipment | $444 million | (5%) |
| Active lifestyle | $320 million | 28% |
| Total segment revenue | $1.17 billion | 12% |
Data source: Topgolf Callaway Brands. YoY= year over year.
Management blamed the soft equipment sales on difficult comparisons to the pandemic's height, when a lot of new players were buying gear. There may be some weakness from inflation creeping in, too, but that shouldn't concern investors, since equipment sales will likely perform better in a roaring economy.
Most importantly, the rest of the business is performing very well, and Topgolf may have a long runway of growth ahead.
2. Growing interest in casual golf
Data from the National Golf Foundation shows participation in off-course golf is surging. Last year, there were more than 41 million golfers over the age of 6 across on-course and off-course participation. This is up from 29 million in 2012, with all the growth coming from off-course.
Considering the long-term tailwinds behind off-course golf, the company continues opening new locations, which should pad revenue growth for many years. It plans to expand Topgolf venues from 82 to 92 this year.
Moreover, the company continues to see growing traffic at existing locations. In the first quarter, same-venue sales grew 11% year over year, and management expects full-year same-venue sales to remain positive in the mid- to high single-digit range.
3. Profitable growth
Despite the flattish participation in on-course golf in recent years, total revenue still doubled between 2013 through 2019. The company made a few acquisitions that boosted its top-line growth during this period, including apparel and accessories manufacturers Ogio, TravisMathew, and Jack Wolfsin.
Still, revenue growth isn't enough. At some point, there needs to be profitable growth for the stock to deliver sustainable returns. On this front, management has delivered.
The stock still outperformed the broader market, as margins improved significantly. After a dip in revenue and profits in 2020, the company reported a $257 million operating profit in 2022, up from $133 million in 2019. Even as the company acquires other businesses, it is doing so while focusing on the bottom line. Over the last 10 years, operating profit grew much faster than revenue.
Data by YCharts
Investors can see management's thinking here. There are limited growth opportunities just selling equipment to regular golf players.
To supercharge growth, management is making profitable acquisitions that are providing different channels within the world of golf to make the sport more accessible for the masses and reward shareholders in the process.
Between 2013 and 2021, the stock returned 225%, beating the S&P 500 index return of 158%.
In fact, all three segments -- Topgolf, equipment, and apparel -- fit very well together, since demand at Topgolf can cross over to sales of equipment and accessories.
The stock has underperformed since hitting an all-time high in 2021, but this is a good buying opportunity. The company should see margins continue to rise, as it expands Topgolf and achieves greater efficiency.
Topgolf generated a small operating profit of less than 1% relative to revenue in the first quarter, so there is a lot of room for improvement. Management recently raised its long-term expectation for venue-level returns and margins, which is a good sign.
With the stock trading about 47% off its previous high, but considering the company's record of double-digit revenue growth, and the opportunities to welcome more people to the sport through the Topgolf business, the stock should grow in value and potentially outperform the major indexes again.
