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Has Callaway Golf Finally Found the Fairway?

By Brian Hill - Feb 12, 2014 at 10:41AM

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With golf participation rates growing slowly in the United States, golf-equipment manufacturers such as Callaway Golf are tapping into international markets and striving to improve operational efficiency in order to build sales and profits.

National Golf Foundation data reveals that the number of golfers in the United States dropped nearly 16% between 2005 and 2012. The game, however, is emerging from its doldrums, as indicated by the 5.7% increase in the number of rounds of golf played between 2011 and 2012.

Today we focus on Callaway Golf (ELY -1.76%) and another company with a very strong presence in the golf-equipment and apparel industry, Nike (NKE -2.68%). We'll also look at sporting-goods retailer Big 5 Sporting Goods (BGFV -0.98%), which sells golf equipment. 

From intensive care to outpatient
Callaway is such an iconic brand in golf equipment that unless you paid close attention to its financial results, you would never suspect any trouble. In 2011 and 2012, however, the company incurred losses of $172 million and $123 million, respectively. On a percentage of revenue basis, the losses are similarly dismal at 19.4% and 14.7%, respectively. That's some serious hemorrhaging.

That's why its recently released full-year 2013 results, showing the net loss trimmed to $20 million, represents a dramatic reversal of the company's fortune. 

Delivering above-par performance soon, Callaway hopes
Callaway is becoming a leaner, more strategically focused company. It divested two brands, Top-Flite and Ben Hogan, so it could concentrate on its core products: the Callaway brand woods and irons and golf balls. And it transitioned its apparel and footwear segments into a licensing rather than manufacturing model, thus saving costs. 

Total revenue was up only 1% for 2013 over 2012. If you remove the revenue from the sold and licensed brands and consider only the going-forward core businesses, however, sales growth was 14% for the full year and an outstanding 17% for the fourth quarter. For the full year, sales of drivers and fairway woods were up 28%.

Sales were outstanding in Japan, up 26% for the core brands, indicative of the opportunity for the company internationally.

The company's operating margin shows that the turnaround is proceeding nicely. The full-year gross profit as a percentage of revenue rose a full 7 percentage points year over year to 37%. Operating expenses as a percentage of sales were down 5 percentage points -- and down $38 million in dollar terms.

The company's 2014 guidance suggests that sales for the year will be $880 million to $900 million. At the high end of that range, results represent a healthy 6.8% increase over 2013. Callaway forecasts that the company will reach profitability again for the first time since 2008, with estimated pre-tax income of $15 million to $19 million.

Take advantage of diversification
Investors who are interested in sporting goods but not quite sure they want to depend on the golf industry growing significantly could consider Nike, the equipment and apparel giant that offers products across many different sports.

In mid-December, the company reported its fiscal 2014 second-quarter results. Revenue was up 8% from the year-ago quarter to $6.4 billion. The gross margin percentage improved a very impressive -- for a company this huge -- 140 basis points, as the sales mix shifted to higher-margin products. The company also continued to grow its high-margin direct-to-consumer businesses.

Nike spent 13% more on demand creation than the year-ago quarter to support new product launches and participation in important sporting events, such as the Winter Olympics. Nonetheless, net income from continuing operations rose 3% for the quarter and was up 19% for the first six months of the fiscal year.

"Our strong second quarter results show why Nike leads the industry," said CEO Mark Parker. Hard to argue with that.

Another choice would be Big 5 Sporting Goods, a retailer that is particularly dominant in the Western states, with more than 200 locations in California alone. Big 5 has relatively small stores, 11,000 square feet or so, which saves on inventory and facilities costs.

Its success depends on deftly picking inventory items that fit the needs of consumers at individual stores. Big 5 offers good values on a range of sporting goods, including camping, hunting, fishing, tennis, team sports -- and golf.  

In its recently released fiscal year sales results, the company reported that net sales increased 5.6% year over year to nearly $1 billion. Same-store sales were up a very nice 3.9%.

The company has been investing in an expanded e-commerce platform, which should help boost sales in upcoming quarters, and is focused on margin improvements through more efficient cost controls.

The rebirth of Bertha 
Innovation is one of the keys to success in Callaway's industry. With each of the major brands promising their clubs are the answer to playing better golf, the battle for market share is intense because it can be difficult for an individual golfer to determine which club really is best.

For example, one of Callaway's competitors is promoting its "new BiO Cell drivers with MyFly8 loft adjustment and cell weighting technology." I'm an avid golfer and have no idea what that means. 

If you asked the average golfer to name the most famous Callaway product, the answer would be "Big Bertha" drivers. The company is relaunching this product in 2014 with improvements such as "adjustable perimeter weighting technology," a sliding weight in the driver head that the golfer can adjust to hopefully hit the ball longer and straighter. I think I understand that one.

Will the turnaround succeed?
Consider that in 2008 -- the last year the company earned a profit -- Callaway's worldwide sales were $1.1 billion but were only $842 million in 2013, a decline of nearly 25%. It will take outstanding strategic execution for this company to build its sales back up to previous levels.

The CEO of Callaway, aptly named "Chip" Brewer (someone named Duff or Hack probably would have difficulty securing an executive position with this company), cautioned on the earnings conference call, "Turnarounds take time." 

And it can be difficult for individual investors to measure where the company is in the turnaround process -- near the end or still in the middle. Sometimes companies keep churning through different strategies and don't completely emerge from trouble -- maybe these should be called churnarounds.

Long-term investors might consider letting the Callaway turnaround come into sharper focus before choosing this stock. Remember, the company hasn't reached profitability yet.


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Stocks Mentioned

NIKE, Inc. Stock Quote
NIKE, Inc.
$106.44 (-2.68%) $-2.93
Big 5 Sporting Goods Corporation Stock Quote
Big 5 Sporting Goods Corporation
$12.07 (-0.98%) $0.12
Callaway Golf Company Stock Quote
Callaway Golf Company
$20.10 (-1.76%) $0.36

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