What's the idea?
- Increasing interest in golf will attract new customers.
- Stable high growth rates can boost investors confidence and support stock prices.
- Increasing EBITDA will reduce the company's level of debt burden.
Topgolf Callaway Brands Corp. is a tech-enabled modern golf and active lifestyle company. It provides variety of golfing experiences, designs and manufactures premium golf equipment, sells clothing and other accessories for golf and active lifestyle.The company operates through three segments:
- Topgolf — Topgolf-run golf establishments
- Golf Equipment — production of golf clubs and golf balls
- Active Lifestyle — production of soft goods under the Callaway, TravisMathew, Jack Wolfskin and OGIO brand names
Why do we like Topgolf Callaway Brands Corp?
Reason 1. Growing interest in golf
According to Sports & Leisure report, there are positive trends in the golf industry:
- In 2022, 54% of interviewed golf clubs reported an increase in number of members. At the same time, 43% said that the clubs had full occupancy or maintained waitlists.
- 77% of players said golf had become a more welcoming sport, and 61% said they were playing more golf with family members than they did a year ago.
These trends are reflected in Topgolf metrics. In its presentation for investors, the company cited the following conclusions from a National Golf Foundation study:
- 75% non-golfers who had visited Topgolf said they were now interested in playing on a course.
- Beginner golfers who had played at a golf entertainment venue such as Topgolf are 20% more likely to continue playing golf regardless health or financial setbacks.
Positive market trends will be a good help for the company's performance in its ket business segments, which we will describe more in detail below.
Reason 2. Company’s potential
Topgolf Callaway Brands runs a well diversified business. 39% of the company’s revenue is generated by the Topgolf segment, while 35% comes from Golf Equipment and 26% from Active Lifestyle. Below we will take a closer look at these segments in the given order.
Topgolf performed well in terms of SVS (Same venue sales, or sales at the company-run establishments that have been operating for at least two years). Compared to the pre-pandemic year of 2019, the indicator increased by 11% in Q4 and by 7% in 2022. In addition, as shown in the chart below, the company opened 11 new establishments during the year (6 of which were launched in Q4). Thus, the growth accelerated in Q4.
We expect further growth acceleration in the segment in the near future, due to the expansion in the number of venues, the launch of a national advertising campaign in early 2023 and the company’s partnership with PGA of America, the US largest professional golf association.
In terms of market prospects, Allied Market Research forecasts the golf club market to grow with a compound annual growth rate (CAGR) of 3.9% from 2022 to 2031.
The company's management also expects good growth rates for the segment — by 2025 the segment’s adj. EBITDA is seen to be more than half of the company's total and exceed $800 million. According to the forecast, the adj. EBITDA number will increase with a CAGR of 15%-18%.
The Golf Equipment segment, in our opinion, will grow due to the increasing popularity of on-course playing, which requires special equipment. In 2022, the number of such golfers has grown by 500,000. In addition, the following factors are expected to positively contribute to the segment’s growth:
- new partnership contracts with celebrities
- new product launches
In addition, according to The Brainy Insights, the golf equipment market is expected to grow at a CAGR of 5.3% by 2030.
As for the Active Lifestyle segment, it has good prospects of growth through brand expansions. Thus, the TravisMathew brand, owned by TopGolf Callaway, has opened 11 new retail outlets in 2022 and aims to increase the number to 50 retail outlets by the end of 2023. In terms of the segment perspectives, FactMR forecasts the sportswear market to grow with a CAGR of 6.9% from 2023 to 2033.
Topgolf Callaway's ongoing efforts will help the company to increase brand awareness among a growing audience and increase market share, which will positively impact the company's financial performance and stock price.
Topgolf Callaway's financial performance in the last 12 months:
Revenue: increased from $3.13 billion to $4.00 billion
Operating income: rose from $204.7 million to $256.8 million:
operating margin almost unchanged — a decrease from 6.5% to 6.4%
Net income: decreased from $322.0 million to $157.9 million:
in terms of net margin, there is a decrease from 10% to 4.0%, due to the recognition of a one-time gain of $252.5 million in 2021 from the company's investment in Topgolf before the merger.
Operating cash flow: a decrease from $278.3 million to $-35.1 million, mainly due to negative changes in Other assets and liabilities. The company did not provide details of these changes.
Free cash flow: a decrease from $-44.0 million to $-567.4 million. This decrease is due to an increase in capital expenditures from $322.3 million to $532.3 million.
Topgolf Callaway's financial performance in the last reporting period:
Revenue: increased from $711.7 million to $851.3 million
Operating profit: rose from $-54.7 million to $-34.7 million:
operating margin — an increase from -7.7% to -4.1%, due to the reduction of SG&A expenses in terms of % of revenue from 32.2% to 29.4%
Net income: decreased from $-26.2 million to $-72.7 million:
net margin — a decrease from -3.7% to -8.5% because of a negative change in income tax provisions
Operating Cash Flow: decreased from $31.5 million to $-69.7 million because of a negative change in working capital
Free cash flow: decreased from $-91.9 million to $-248 million, due to an increase in capital expenditures from $123.4 million to $178.3 million
The company showed good results both in the full year and in the last quarter. In our opinion, the decrease in net income was due to the one-off effect of a high base (for comparison, net income was $-126.9 million in 2020 and $79.4 million in 2019). The decrease in cash flows was caused, among other things, by higher capital investments to business expansion, for example, Topgolf opened 11 establishments during the year. We expect improvements in relative indicators in 2023.
- Cash and cash equivalents: $180.2 million
- Net debt: $1.88 billion
- Net debt / adj. EBITDA: 3.4x
Topgolf Callaway has a high level of debt burden, but plans to gradually reduce it to the 3.0x target by 2025. Taking into account the fact that the company’s total amount of liquidity is $415 million, this level of debt burden carries certain risks for investors. However, we believe that this fact is already reflected in the company's stock price, and fast growth rates will help Topgolf to ease the burden thanks to increasing EBITDA.
In terms of trading multiples, the company is undervalued relative to its competitors based on all indicators, except for P/CF (30.23x vs 18.78x) and P/E (30.67x vs 21.07x). However, we believe net income margin and cash flow will recover next year, bringing P/E and P/CF valuations in line with industry averages.
Topgolf Callaway does not pay dividends, but has a $100 million buyback program, of which a $25 million buyback was completed in 2022. It leaves $75 million remaining, which corresponds to ~1.7% of the company's total market capitalization.
In 2023, the company's management expects revenue in the range of $4.42 billion - $4.47 billion, which would be equivalent to an increase of 10.5%-11.9%. Adj. EBITDA is expected to be in the range of $620 million - $640 million, meaning an increase by 11.1-14.7%.
We believe that through the continued business expansion and effective partnerships, Topgolf Callaway will be able to achieve its goals, which will have a significant positive impact on its stock price. We expect the effect to be seen after the publication of Q3 results with summer profits.
Other investment companies’ ratings
The minimum price target set by Cowen and Company is $21 per share. Compass Point Research & Trading LLC, in turn, sets a target price of $37 per share. According to the consensus, the fair value of the stock is $32 per share, which implies a 49.89% upside potential.
- The company has a high level of debt burden, which may make it impossible to carry out M&A deals when an opportunity arises and make it difficult to maneuver in the case of unexpected difficulties.
- In the case of a new, more “fashionable” sport for wealthy people to emerge, it can negatively affect the company’s growth rates.
- Despite the lower demand elasticity of golf compared to other sports, a potential economic recession could have a noticeable negative impact on the business.