HONMA Golf, expanding premium niches in the market

Overview

HONMA Golf Ltd –incorporated in Cayman Islands, listed on Hong Kong Stock Exchange with ticker 6858 and headquartered in Tokyo– is a prestigious and iconic brand in the golf industry.

The company utilizes innovative technologies and traditional Japanese craftsmanship to provide golfers across the globe with premium, high tech and the best performing golf clubs, balls and accessories.

The Group’s sales and distribution network consists of HONMA-branded self-operated stores as well as distributors, and develops and manages its sales and distribution network on a country-by-country basis to cater for the specific retail landscape and consumer demographics.

As the only vertically integrated golf company with in-house design, development and manufacturing capabilities, a strong retail footprint in Asia and diverse range of golf clubs and golf related products, HONMA is positioned to grow its business in Asia and beyond, benefitting from the return of golfers in mature golf markets such as US and Japan and from increased participation in golf´s new markets such as Korea and China.

As of Jun 17th, 2019, HONMA´s market capitalization was HK$4,263 million with 609 million shares outstanding at a value of HK$7.00 each.

Back and Current Story

Founded in 1959, HONMA fell on hard times with the collapse of Japan´s bubble economy in the 1990s. It had overinvested in golf courses and made other missteps. In 2005, it filed for bankruptcy protection, and in 2010 – in what many Japanese viewed as a painful indignity – it was bought by a Chinese fund run by businessman Liu Jianguo who also operates a Shanghai company that makes hair dryers and rice cookers. Yet Liu Jianguo became Chairman and President of HONMA since then.

In October 2016, the company went public at HK$10 without fanfare and Liu Jianguo turned HONMA around by revamping its sales strategy since then –Ұ18,525 millions revenues in period 2014-2015 and Ұ27,770 millions revenues in period 2018-2019, so a CAGR 4 Years of 10%–.

Although revenues has been decelerated from 21% in 2016 down to 6% in 2019, EBIT margin has maintained around 20% which makes sense, as I will describe later, with the strategy of the company.

The charts below set forth the breakdown by region and product of the total sales in 30mar19.

As we see HONMA have a strong presence in its home markets of Japan, Korea and China (including Hong Kong and Macau), while clubs represents by product the most important source of revenues.

Global Golf Products Industry Overview and where fit HONMA

Golf is a sport which boasts worldwide popularity and is enjoyed by millions globally. The sport involves players using various types of clubs to hit balls into a series of holes with the aim of minimizing the number of strokes required. To play golf, a golfer needs a set of clubs of various lengths and sizes, a set of golf balls and related accessories such as gloves and bags. These products make up the core of the global golf products market. Golf apparel includes clothing and shoes targeted at the golf lifestyle market and forms another important segment of the golf products market.

Key market players supporting the market expansion significantly include Callaway Golf Company, Amer Sports Corporation, MIZUNO Corporation, TaylorMade Golf Company, Inc., Acushnet Holdings Corp., Roger Cleveland Golf Company, Inc., Parsons Xtreme Golf, LLC, Bridgestone Sports Co., Ltd., Honma Golf Co., Ltd., and Epon Golf.

Although global retail sales has been stagnated since 2014 (US$13.4B), HONMA has been able to increase its market share from 1.5% at 2015/2016 to 1.9% at 2018/2019.

The following factors are expected to be key drivers of growth for the golf products industry over the next several years:

• New Markets and Demographics. Golf has traditionally been under-penetrated in emerging markets. In recent years, more people in emerging markets, especially in Asia, have started to play the sport, driven by increasing disposable income, higher standards of living and greater emphasis on leisure activities. Meanwhile, golf has also gained greater popularity among women and the younger generation worldwide, as a result of the increasing perception of golf as a “lifestyle sport”, a new generation of young golfers coming to prominence on the professional circuit, and additional marketing efforts by golf brands towards these demographics.
• “Lifestyle Sport” Proposition. Positioned as a “lifestyle sport” with an element of prestige that accommodates competition, entertainment and physical exercise, golf appeals to modern consumers who pursue a higher quality lifestyle with an increasing awareness for health and wellness.
• Golf ’s Return to the Olympic Games. The reinstatement of golf at the 2016 Olympic Games significantly raised the profile of the sport worldwide. As we edge closer to the 2020 Tokyo Olympic Games, global attention is slowly starting to focus on Olympic qualification. With Japan hosting the 2020 Olympics, the golf markets in Japan and other parts of Asia are expected to receive a significant boost in the build-up to the Olympics.
• Digitalization of Retail Channels. Digital retail channels such as e-commerce, mobile commerce and social commerce now address consumers’ purchase preferences, which were predominantly restricted to brick and mortar stores in the past. These emerging channels play vital roles in penetrating different consumer segments.
• Technological Innovation. Golf products development has always been driven by technological innovations over the years. Further developments in clubs, balls and related products are expected to make the game more accessible, enjoyable and exciting, while continuing to attract new players.

According to HONMA Golf, consumer preferences for golf clubs can be classified under two key dimensions:

• the willingness to spend, or acceptable price of clubs; and
• the degree of enthusiasm for golf. The degree of enthusiasm can be measured by the consumer’s skill and participation level, which is score for playing one round of golf, as well as number of rounds played within a particular time period.

Based on the two key dimensions described above, the golf clubs market can be segmented into the 9 Key Segments, each consisting of a unique type of golf club consumer.

HONMA currently offers golf clubs mainly under three major product families, namely BERES, TOUR WORLD and BeZeal, each targeting specific consumer segments:

• BERES golf clubs target consumers in Segment 2, which is the Group’s traditional customer base and comprises affluent consumers willing to pay a premium price for golf clubs
• TOUR WORLD golf clubs target consumers in Segment 6, which comprises golf enthusiasts who place a higher emphasis on performance
• Be ZEAL golf clubs target consumers in Segment 5, which comprises beginner golfers who are looking to improve their performance.

Segments 5 and 6 are experiencing faster growth rates compared to the overall growth rates of major golf markets.

How good are the existing investments

On March 30th, 2019, HONMA presented its results for the last fiscal year. The company earned  ¥4,732.0 million as after‐tax operating income on a book value of capital invested of ¥16,357.6 million, while the net income was ¥4,127.5 million on a book value of equity of ¥28,050.0 million.

The after‐tax return on capital based upon these numbers is 29% and the return on equity is 15%.

With after tax return on capital of 29% and relative to the cost of capital of 4.64%, HONMA seems to be earning an excess return of 24.29%. With a return on equity of 15% and relative to the cost of equity of 4.99%, HONMA earns an excess return of 9.72%.

Therefore  HONMA has a positive amount Economic Value Added both to capital and equity:

Since IPO in 2016, HONMA has focused in targeting niches of golf market which are willing to pay a premium for golf clubs. In order to increase sales in these segments, the company has launched several golf clubs families in the last 3 years to align with its target consumer´s preferences. This growth strategy can explain both high ROC and ROE.

Valuation

A plausible story for the future of HONMA could be an exclusive golf company, with low production and medium/high prices. The benefits of this strategy are high operating margins partly because of the high prices, and partly because the company does not have to spend much more on expensive ad campaigns or selling than it is doing now (currently 11% of revenues). It also will keep reinvestment needs to a minimum, since capacity expansion will not be necessary, though the company will continue spending on R&D to preserve its edge (currently 1% of revenues). In addition, by focusing on people with more purchasing power around the world, HONMA may be less affected by macroeconomic forces than other golf companies.

The inputs into my valuation reflect the story, with low revenue growth, high margins and low reinvestment, driving value:

1. Revenues growth of 5% a year for next 5 years, scaling down to the current risk free rate -0.84% in year 10
2. HONMA´s EBIT Margin stays at 20%, the current margin in last year
3. Sales/Invested Capital stays at 1.52 reflecting the little need for capacity expansion
4. Cost of capital of 4.67%, scaling down to global industry average

Other relevant inputs to be assumed:

1. Many growth companies fail, especially if they have trouble raising cash. In case of HONMA, I will give a 10% probability of failure with a distress proceeds of 0% if assets are worth nothing in case the firm would fail.
2. HONMA will earn a ROC equal to 15%, greater than its Cost of Capital. I am assuming that the firm will maintain its alleged competitive advantage (given by its incremental market share and high ROC & ROE) in the long run.

With all these inputs and others not described on this post, the resulting value is shown below:

The value for equity give us Ұ91,856 million which dividing to number of shares 613.26 million, give us Ұ149.78 per share (or HK$10.34) well above the stock price of HK$6.78.