There aren't many stocks that have survived the selling onslaught during the 2022 bear market. Many stocks deserved these price cuts because of their absurdly high valuation multiples and/or uncertain business models. However, investors have thrown out the proverbial baby with the bath water when selling stocks this year.
Golf conglomerate Topgolf Callaway Brands (MODG -1.66%) is one of these companies (it is down 25% this year), and it now trades at a cheap valuation. Here's why Topgolf Callaway is an easy buy for investors looking to hold for many years.
It's all about Topgolf
In early 2021, Callaway completed its merger with Topgolf, an innovative driving range and entertainment concept that is rapidly growing across the United States. Topgolf locations offer a fun atmosphere for golfers of all skill ranges, along with serving food and drinks, providing a perfect venue for parties and group events. Last quarter the segment did $414 million in revenue even though there are less than 100 locations open around the world.
With so few locations, Topgolf Callaway has an opportunity to open tons of new venues this decade. Management plans to open around 10 new venues a year (11 are slated to open in 2022) for the foreseeable future. Topgolf is also seeing strong growth from its existing venues, with same-store sales up 11% last quarter vs. 2019. 2020 and 2021 were tough periods for Topgolf, with customer volumes down due to the COVID-19 pandemic, and are not good comparisons for a normalized operating environment.
Topgolf will soon be doing $2 billion in revenue a year. If it can double its venue count sometime this decade while also achieving consistent same-store sales growth, the segment looks to be well on its way to hitting $5 billion in annual revenue before 2030. Assuming it can hit a 10% profit margin, that equates to $500 million in annual profits for Topgolf Callaway.
But don't forget the other half of this business.
Don't forget apparel and equipment
Outside of Topgolf, there is the namesake Callaway golf equipment brand, and a few apparel brands that the company has acquired over the years. The golf equipment business is steady but not a fast grower, with revenue only up 2.5% year-over-year last quarter. However, it does have solid profit margins, which allowed it to achieve just shy of $50 million in operating income last quarter. Over the first nine months of 2022, the Callaway equipment segment brought in $250 million in operating income.
The growth driver for apparel and equipment will be the active lifestyle brands, which include things like Travis Mathew and Jack Wolfskin. Management says this segment is on track to deliver $1 billion in revenue this year, and grew revenue 19% last quarter. With approximately 10% operating margins, the active lifestyle segment should easily generate $100 million in operating income this year along with solid revenue growth.
It doesn't have as clear a path as Topgolf to growing sales (apparel is notoriously trendy and unpredictable), but it has the chance to be a solid contributor for Topgolf Callaway this decade.
Valuation? Not too crazy, but there are some complications
Right now, Topgolf Callaway has a market capitalization of $3.8 billion. Adding back net debt of $1.54 billion, the stock currently trades at an enterprise value (EV) of $5.34 billion. Compared to its net income of $204 million, the stock trades at a trailing EV-to-earnings (EV/E) of 26, which is slightly above the market average. The company is also burning tons of free cash flow due to its heavy investments to grow the Topgolf segment.
MODG Net Income (TTM) data by YCharts
But investors shouldn't look at Topgolf Callaway's earnings multiple in a vacuum. Management is still investing heavily for growth at the moment, which is depressing earnings. If you combine the potential earnings power of Topgolf, the equipment business, and the active apparel brands, Topgolf Callaway has an potential road to generating over $1 billion in annual profits sometime this decade.
Compared to its current EV of just $5.3 billion, that looks quite cheap and indicates to me that the stock has the potential to go up by multiples in value over the next five or so years.
