Fernando H. Green Blog: The Callaway Juggernaut: What Do 2018 Financials Say About Golf Equipment’s #1 Company?

Callaway may very well be the New England Patriots of golf. Snide remarks aside, they just keep playing the game better than anyone else.

The company’s 2018 financials are out and even after sifting through some of the accounting shenanigans designed to make investors wet themselves with glee; the only conclusion one can draw is this:

Callaway killed it.

To the tune of $1.243 BILLION in sales.

That’s rarified air, folks.

The Money-Go-Round

That $1.243 billion in sales represents a 19% increase (nearly $200 million) over 2017. More importantly, Callaway is reporting an operating income (pre-tax) of $128 million, a whopping 62% increase over 2017 profits of a paltry $79 million.

“These results reflect not only the strength of the Company’s 2018 product line, continued brand momentum and favorable industry and macroeconomic conditions,” says CEO Chip Brewer, in a prepared statement, “but also the benefits of our acquisition growth strategy.”

Callaway purchased both TravisMathew and OGIO in 2017, which helped fuel growth and profitability. Travis Mathew alone added approximately $60 million in sales.

Callaway’s net income (post-tax) was a tad under $105 million for 2018. On net sales of $1.24 billion, that’s an overall profit margin of approximately 8%.

2018 net sales by product category compared to 2017 tell a more detailed story:

Woods: DOWN 1.1%
Irons: UP 26%
Putters: UP 14%
Golf balls: UP 20%
Gear/accessories/other: UP 36%

These numbers represent dollars as opposed to units and don’t necessarily reflect market share trends up or down. We can, however, make a few conclusions.

First, the Rogue metal woods story maybe didn’t catch fire in the wake of the original Epic (hence the Epic Flash for 2019) as dollar sales for metal woods actually went down compared to 2017, albeit not by much. The Rogue irons, however, were en fuego – selling well and contributing to positive growth. A 20% jump in golf ball sales isn’t anything to sneeze at either.

Most importantly, though, is the 36% jump in gear/accessories/other – clearly a function of adding TravisMathew and OGIO to the product mix. Before tax income by product category rounds out the story.

Callaway sold just over $717 million worth of golf clubs in 2018, with a pre-tax income of slightly more than $104 million, for a 14% pre-tax profit margin. The company sold $196 million worth of golf balls, which turned a pre-tax profit of nearly $28 million, again a 14% margin.

In gear and other accessories, Callaway sold nearly $330 million worth, with a pre-tax profit of nearly $57 million, a 17% margin.

What these numbers suggest is that while Callaway remains a golf club company, there’s gold to be mined with TravisMathew and OGIO. While gear/accessories sales were less than half of the club sales, the return on those sales was more lucrative, and the opportunity for growth is very appetizing.

Which explains the Jack Wolfskin acquisition.

Jumpin’ Jack Flash

The deal to buy Jack Wolfskin for $476 million was announced in November and finalized January 4^th. Jack Wolfskin is a premium outdoor apparel, footwear and equipment brand headquartered in Germany. It’s a lifestyle brand for hikers, cyclers, skiers, campers and mountain climbers – with golf gear noticeably absent from its website.

The brand had net sales of $380 million in fiscal year 2018, with a net profit of $10.6 million – or just under 3%. While that return seems fairly low, Jack Wolfskin is very strong throughout Europe and Asia. Why is that important? While Japan is Callaway’s 2^ndlargest market (behind the U.S.), the rest of Asia represents a major opportunity for growth. Callaway’s core business in the rest of Asia increased by 20% in 2018, while Japan grew at just over 12%. That 20% increase, however, is based on total sales of less than $93 million. There’s clearly room for substantial growth.

For the record, Callaway’s U.S. business grew 25% in 2018, while its European business grew only 6%.

In announcing both the Jack Wolfskin acquisition and its own 2018 results, Callaway highlighted EBITDA – a financial calculation used to value a company and measure its potential profitability. EBITDA stands for Earning Before Interest, Tax, Depreciation, and Amortization, and has its detractors in the financial world. EBITDA is net profit with interest, taxes, depreciation, and amortization added back in, and does not fall under what are called Generally Accepted Accounting Principles.

Highlighting EBITDA isn’t necessarily financial chicanery. Callaway has consistently expressed EBITDA in its annual reports, but 2018 is the first time it’s been shown in the headlines of a financial report press release in at least six years. EBITDA detractors say a company will highlight EBITDA when it doesn’t have an impressive net income, has borrowed heavily or is experiencing rising capital and development costs.

Based on an actual net profit of only 3% on sales of $380 million, on the surface, the Jack Wolfskin purchase is a bit curious for Callaway. But once interest, tax, depreciation, and amortization are taken out of the equation, Jack Wolfskin’s EBIDTA is over $40 million which, depending on a deeper analysis of Jack Wolfskin’s financials, the purchase could be a potential steal.

Purple Haze

One line in Callaway’s press release was particularly interesting: margins were driven by continued pricing opportunities, as well as the TravisMathew business. Now, it’s fair to ask if continued pricing opportunities mean price increases to the consumer or lower costs to the company – most likely it means both.

It’s clear no one like paying higher prices for golf equipment – that’s a given. But is an 8% net profit for a publicly traded company with over $1.2 billion in sales excessive? If you happen to own Callaway stock, you’d probably say no. You invest in Callaway because you want to see a return on the money you give them, and a healthy, profitable Callaway would be in a good position to do just that.

If the fact the company is profitable offends you, there are alternatives – but you may wish to consider that a healthy Callaway is good for golf.

We all know the common narratives: bloated marketing budgets, spoiled tour players, obscene profits are pricing equipment out of the reach of the average golfer and are driving people away from the game. Those narratives, however, don’t disguise the fact Callaway has kissed the sky with $1.2 billion in sales.

The cynic may point out the last company to reach that sales level was TaylorMade, and look what happened to them. It’s important to note the two companies hit those sales numbers in very different ways. Much of TaylorMade’s empire was a house of cards, built on flooding the market with huge amounts of heavily discounted product. Yes, a ton of sales and market share – but market share with no margin is a recipe for disaster.

Callaway’s approach has been smarter and more controlled. Yes, they have a lot of clubs, but inventory is controlled, club release cycles are at least one year per category (often two). Also, while Callaway sold over $717 million worth of golf clubs last year, it sold over $526 million worth of other stuff, nearly 42% of its total sales.

What’s clear is the acquisitions of TravisMathew, OGIO and now Jack Wolfskin not only add to Callaway’s profitability, they also provide Callaway with something TaylorMade – as a standalone division of adidas – didn’t have: a means to equipment-proof the business.

Golf equipment remains Callaway’s bread and butter, but if the unthinkable happens and the equipment end has a down year, there’s a healthy mix of additional products to offset any hiccups. And when it comes to more acquisitions, the smart money says Callaway probably isn’t done.