GOLF | Press the Short

1Q sales were down 6% reported, a bit better than we expected, GAAP earnings were down 75% which was worse than we expected.  Both revs and adjusted EBITDA came in below the street. Golf balls were down 17% in a quarter that had minimal Covid19 impact, and that saw US rounds played up over double digits YY due to an unusually mild winter. The street is modeling balls down 10% for the year, it should be down at least twice that. Clubs were actually up 3% in 1Q, with new lines of wedges and putters recently introduced and the T-series irons seeing sales before the Covid impacts, that will reverse significantly in 2Q. Drivers and fairways were down as they are in year 2 of their product cycle. Adjusted EBITDA was down 17%, we’d argue management got too liberal with some of the adjustments (expenses like employee wages and benefits are non-recurring just because of Covid?) so we’ll call that down 30%.  That’s a 76% decremental EBITDA margin. The street currently expects EBITDA down 20% for the year, we think the real number will be closer to down 50%, potentially more.  If we look forward to “recovery” earnings, the street has EPS of around $1.50 for 2021/22, just 10 cents off the peak 2019 earnings when the consumer was as good as it had been in decades. Massive unemployment and the economic recession/depression will have significant and lasting negative effects on the golf industry, golf participation, and most importantly golf equipment spending.  We don’t expect to see $1.00 in earnings for at least 3 years. GOLF remains a Best Idea Short and we’d be pressing at these prices with the earnings catalysts ahead.

Bright Spots

• South Korea has been a model in Covid-19 case management, and the business for Acushnet has apparently recovered quickly there.  Rounds are expected to be positive through April, which is perhaps indicative of people needing to get outside post home quarantine (which was more aggressive in Korea than the US). We don’t expect that to last and we think the sales and earnings profile in Korea will still be reduced vs prior trends given macro-economic impacts, but it’s at least not seeing crashing sales like other regions around Covid-19 impacts.
• Inventory in balls appears to be cleaner than the worst case scenario.  Production shutdowns and delayed/cancelled orders for green grass facilities means the channel isn’t stuffed with balls.  But that is slightly net bullish for pricing, though sales will be bad as we repeat managements words from the prior sentence “delayed or cancelled orders”.  Footjoy channel inventory is down YY which is a positive given the category is getting promotional.

Negatives

• Inventory in wedges and putters sounds high as the products had just launched, there will be a lot of this product to try to move come late season, though the company does do 2 year product cycles so at least it can sell some next year, but that’s still a net negative on equipment sales and margin outlook.
• Irons, as the company noted are often done via custom fitting/special order, that’s a positive on how lean inventory is, but it’s a sales negative since there are probably very few custom fittings happening.
• Driver/fairway inventory will be in clearance mode come late summer/fall given it's year two of the products.  There will not be much demand for those with demo days limited this season.
• Japan is starting to see weakness from recent social distancing actions after being relatively stable in the early part of the year.
• The company was lacking specifics in terms of recent trends and general commentary sounded overly positive to us, but the state of the US business is bad, we’ll try to give some context on it below. This line from management sums up how investors should be looking at the outlook “The pace at which consumer spending resumes remains to be seen, as does the degree to which retail activity will be impacted over the course of 2020. We are bracing for increased promotional activity in the coming months as stores reopen and the market recovers.”

Areas Where We Disagree With Management

• First item we take issue with is management's non-GAAP adjustment for “salaries and benefits paid for associates who could not work due to government mandated shutdowns, fringe benefits paid for furloughed associates, spoiled raw materials, incremental costs to support remote work and the cost of additional health and safety equipment”.  These are mostly expenses occurred so you might be able to re-deploy your employees at a future date, that’s an ongoing business expense. 
• Next, we have seen just a few companies remain committed to a dividend in the face of unprecedented pressure and uncertainty in demand.  When you are taking actions to preserve cash and liquidity throughout the company including employee wage cuts/furloughs, we think it is bad risk management to maintain a dividend. Perhaps part of the market reaction is around the declared 2Q dividend, but the dividend will mean little with where we think earnings are going.
• We found some of the commentary from management to be misleading in the absence of detail metrics on near term trends.  Quotes like “encouraged by the recent beginnings of recovery within the golf industry”, “golf courses 90% operational” suggest a state of the business that is much rosier than what we understand it to be.  We understand not wanting to be alarmist, but we think management teams should be sticking to the facts in a time of such uncertainty, not pointing to potential positives.  We’d like to know what sales look like with courses 90% "operational" (NGF has it at 79% as of May 3^rd fyi) given clubhouses often remain closed.
• We agree Acushnet is well positioned for the long term operating in golf, it has quality brand positioning, but we disagree when it says “we believe the game is well positioned for the post-pandemic world, and this bodes well for our business in the long term”. Golf is not well positioned for long term growth in the US economy.  Perhaps pre-Covid validation of this is GOLF’s acquisition of a European ski outwear brand in KJUS last year, rather than investing in its core. We do not think golf will not see a participation benefit from the long term effects of Covid, in fact we think the economic pressure on the industry will mean the opposite, ie closed courses, closed retailers, and players leaving the game as they can’t afford playing anymore.  How would golf be able to grow? Well the industry needs to find a way for the game to be 1. Faster/Less time consuming  2. More inviting/inclusive  3. Easier/more fun to play  4. Less expensive.  The industry has been trying to do that for years with very little success.  The fact that it is played outside and is generally compliant with social distancing will not help long term participation.  Ask a course owner how excited they are about the future opportunity of social distanced golf someday and they will probably just say they hope to still be in business to see it.

What does 2Q look like?

Here are a few things to keep in mind as you think about the forward fundamentals.

• Reminder that iron sales are custom fitting dependent, often on demo days.  There is little of that happening.
• Golf events (outings/tournaments) for 2Q from what we know are almost entirely cancelled/postponed, so there is essentially zero event related sales.        
• The NGF has courses at 79% open as of May 3^rd expecting 87% by this weekend, and 90% by next weekend.  Again that is just open for play, not at full capacity and not openness of retail selling operations on the course.  So you are losing somewhere around 20-30% of play based on openness in 2Q, more is lost based on actual capacity.  For example the golf guidelines set by the NJ governor include groups of 2 (except for immediate family), 15 minutes between tee times, one person per cart (except family).  That takes rounds capacity to something like 30-40% of the normal.  Will every course obey the rules? No, but we still expect to see pressure on rounds played despite courses being ‘operational’.
• Green grass proshops represent about 2x the SQFT of golf retail stores, latest NGF polls have golf shops at about 36% open, 46% of shops at ‘open’ golf courses are open. 
• Golf retail stores are 39% open, up from 17% last week and 4% in April.
• Consumers have showed some concern about shopping golf shops with 10% “very concerned” and 37% “somewhat concerned” to shop them. (Per NGF image below)

All in we think 2Q will see sales down 20-35% and EBITDA down 50% plus.

Source: National Golf Foundation