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Callaway Golf Company

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October 26, 2009 – Comments (3) | RELATED TICKERS: ELY

Callaway Golf Company (ELY)

Callaway Golf Company sell all things golf related. This includes, golf balls, golf clubs, golf gizmos and golf attire. They have products targetting all price points but with a general emphasis on technologically superior products.

The current economic downturn has hurt Callaway's profits badly; both Q1 and Q2 2009 profits fell ~82% YOY. Sales were down 17% over the same period. Despite being hit pretty hard, they did manage to turn a profit.

Callaway has no short or long-term debt and $50 million cash on hand. They recently sold $140 million worth of preferred shares which they used to pay off $90 million of debt on a line of credit. I think this shows that management values a strong balance sheet and that they are financing the company conservatively during this downturn.

Historically, Callaway tend to lose money during Q3 and Q4 and I'm sure this year will be worse than usual. However, this is not unexpected and as mentionned above Callaway have taken precautions to work through the hard times. Given that a weak recovery is projected for 2010, Callaway have already weathered the worst of the storm.

Bullish Argument

My bullish argument is based mostly on fundamentals. Callaway currently has a market cap of just under $499.05 million, but a book value of $632.46 million making a price/book of 0.71. The company is priced less than the value of its assets, so this is a value play.

That book value will probably decrease through Q3 and Q4, but historically it tends to fall by about $100M, meaning the company will still be undervalued. Callaway have been taking measures to reduces costs and expenses like most other companies, so I believe 2010 could see better profits than 2009 even if we see only a weak recovery.

Finally, I don't watch, play or follow golf, but I know the name Callaway. I like companies with a strong recognizable brand name, it is the sort of thing that is hard to acquire, and amazingly hard to loose (see Palm for example.) Callaway also own another brand I recognize, Top-Flite.

Bearish Argument

Callaway have already issued guidance that Q3 will not be stellar. Mr. Market has already reacted to this news, but bad earnings could drag the stock down through Q3 and Q4. If Callaway cannot claw back some of its pre-2009 sales, it is likely this stock will remain under $10 for a long time.

Summing up, I think Callaway is a somewhat risky value play. Either way you hack it, Callaway is currently undervalued, but that could change over the coming year if this continue to go badly. But, given the bonuses Wall St. is paying itself, the golfing class could be back in force for 2010.

3 Comments – Post Your Own

#1) On October 28, 2009 at 11:33 PM, mike514 (< 20) wrote:

You might need to take a second look at your bullish argument. Asset book value in an established manufacturing company alone. For instance, take a look at the 30/06/09 balance sheet and notice that inventory accounts for nearly half of the firm's current assets.

 

The risk involved in holding onto such a high inventory of an item that is sold for not only its technical features, but also its fashionability is non-negligible. You should expand your analysis to investigate whether or not this elevated inventory level is acceptable within the industry or a sign of inefficiency. However, even if it is acceptable, it is also possible that investors perceive it to be risky in an economy where inferior goods are king. 

 

This, coupled with a sharply negative change in cash flow for FY2008 could pull the price down to the levels we're seeing. 

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#2) On October 31, 2009 at 12:39 PM, JWD26 (< 20) wrote:

If you were to take a Ben Graham approach to this analysis, you'd come out with a 2Q 09 book value of ~90M.  [Cash & ST Investments + 0.75(AR) + 0.5(Inventory) - Total Liabilities], which comes out to ~$1.50 per share.  With shares currently around $7, I'm not sure this company represents a compelling value.

The 5 year average ROE for the business is 5%, according to Reuters, which makes me somewhat skeptical that this is a company with a durable competitive advantage.

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#3) On November 02, 2009 at 2:45 PM, assertfalse (90.86) wrote:

Thanks JWD26, that is precisely the sort of comment I was hoping to get with this post. I'm obviously still learning and have a ways to go :)

Is there a reference you could point me to for that rule of thumb. I'm most of the way through "The Intelligent Investor" and still haven't come accross it.

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