Callaway Golf: Still Better Than Par

Excerpts from Gilford Securities analyst Casey Alexander's recent note to clients on Callaway Golf (ELY):

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1. Initiating 2009 Quarterly EPS Estimates

After digesting the Callaway Golf Q3 EPS report, we are initiating our 2009 quarterly EPS estimates. Our full year 2009 EPS estimate stays the same at $1.15 per share. We are also decreasing our full year 2008 EPS by $0.03, to $0.98 per share compared to our previous estimate of $1.00 per share.

2. It’s the election, stupid!

Carville’s famous line, “It’s the economy, stupid” was intended to keep Clinton-istas focused on the message for the election. In this case, Callaway CEO George Fellows has pinpointed that electioneering has devolved into a game of who can throw the most stones at the economy, in order to gain an upper hand in the upcoming Presidential election. The theory that Fellows is suggesting is that once the election is over, the winning candidate will have an almost immediate incentive to discuss economical progress in more favorable terms, and the consumers will respond with more confidence, and therefore economic indicators will improve. He feels that Callaway would benefit from that result. We don’t have an opinion on this position. We just find it interesting...

4. The Value Proposition is Here; Price to EBITDA, PE Ratio at Historic Lows

In our last report we discussed how Callaway was trading at a historically low Enterprise Value/EBITA ratio. The problem was that even though it was historically low as we discussed it, we had it calculated wrong, and too high! Callaway Golf is actually trading at an Enterprise Value/EBITA ratio of 5X EBITDA on this years numbers, and 4.1X EBITDA based upon our EPS estimate for 2009. The 2009 numbers still bake in very little prospect of pent up demand, which suggests to us that numbers could still end up being low for 2009. The credit crisis will not last forever.

Callaway is selling at a P/E of 10.5X 2008’s EPS estimates with the year three quarters over. The shares are trading at 9.1X our 2009 EPS estimate. Do we have great confidence in our 2009 estimate? It’s hard to have great confidence in anything these days, but that is still a pretty compelling valuation, and given the historic trading patterns, ELY still should work from here despite the new lows.

From a market standpoint, Callaway clearly lost some market share domestically. The management would surely point to having three key products in their second season as the reason. But TaylorMade chooses not to let that happen, introducing new product on a regular basis. Perhaps the new introductions here in Q3 and Q4 are a sign that Callaway intends to do a better job keeping fresh product in the pipeline at all times. If so, this could stem the market share losses and allow for better operational performance, especially if the pent up demand for new clubs emerges...

7. Reiterate Buy Rating

The beauty of Callaway Golf is that the shares will probably hit our price target whether the Company actually hits our EPS forecast or not. That is the nature of the seasonal trade.

On the numbers, Callaway is very cheap. Are there issues? There are always issues. But we are at the point on the calendar that we have to start to look past the issues and start to become constructive on building positions in Callaway, before the rest of the world gets excited about golf in the spring.

Our price target is being slightly raised from $14.85 to $15, up 43% from the current price. Based upon the potential return we will reiterate our Buy rating.

Risks to Achieving Price Target

• Failure of new products to resonate with target customers
• Failure of golf equipment sales to stabilize domestically
• Severe deterioration of general economic conditions both domestically and internationally
• Failure to control costs and deliver expected margin improvements

ANALYST CERTIFICATION

I, Casey Alexander, certify that all the views expressed in this research report accurately reflect my personal views of the subject company (ies). I also certify that I have not and will not receive compensation with respect to the issuance of this report.