Excerpts from Gilford Securities analyst Casey Alexander's recent note to clients on Callaway Golf (ELY):
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1. Cutting 2009 EPS Estimate Again
We are cutting our 2009 EPS estimate for Callaway Golf again. While between quarters we can’t seek business updates on Callaway due to disclosure laws, we can certainly seek out and discuss business conditions, outlooks and budget processes for 2009 with private golf equipment companies. And what we have learned is revealing.
We have talked to companies that are forming budgets with a range of potential outcomes, but the best case we have heard thus far is for a sales decline of 10% for the industry for 2009. Believe it when we say we have heard worse. But most companies out there are planning based upon an approximate 10% decline in industry revenues. This is a business that has never had a double-digit decline year. Some of the inputs that are going into these budgets include a) very poor sell through in 2008 Q4; b) inventory levels that are requiring some companies to take product back in order to get placement for 2009 product; and c) continued financial difficulty with the consumer.
Therefore we feel that we need to get to something closer to a 5% decline in revenues year-to-year on Callaway. We also believe that the greater portion of this decline is going to take place in the first two quarters. If companies are budgeting down to this extent, it is because the feedback from the distribution channel is suggesting that they put less product in the channel in the beginning of the year. This means that we have to move our margin assumption down somewhat as well. Therefore we will reduce gross margins in Q1 and Q1 to 47.5% from 49%.
The result of reducing revenues by $20 million in Q1 and Q2 and reducing gross margins will reduce our EPS estimate for Q1 and Q2 from $0.60 per share down to $0.53 per share. This also reduces our full year forecast from $1.06 per share down to $0.92 per share.
We are also going to clip $10 million off of our 2008 Q4 estimate which reduces the loss per share from ($0.19) per share to $($0.22) per share. This is a direct result of what we have seen from the sell through figures, which have been quite poor. For instance, Golfsmith (GOLF) just announced a 17.3% decrease in Q4 2008 Same Store Sales. This will also reduce our full year 2008 EPS estimate from $0.98 per share to $0.94 per share.
2. What are the Positives
For Callaway, 2009 does carry some positives. Callaway has a new product cycle in 2009, or likely our estimates would be going down even further. The Callaway 2009 product line was highly regarded in the Golf Digest 2009 Hot List. We will certainly have more to say about product lines after the PGA Merchandise Show later this month on Orlando, FL. We expect the mood at the Show to be subdued at best.
It is also possible that the massive government stimulus could eventually get consumers back on their feet. The golf consumer is one of the first consumers that will return to a more normal pattern of spending. We also still feel that when the golf consumer re-emerges to a more normal spending pattern that there will be significant pent up demand for golf equipment.
We would also suggest that customers in this environment are going to center their attention on well identified brands for the equipment they do purchase. Therefore aggregate market share for the major brands should increase as the secondary and tertiary brands struggle. Price will become a more important weapon for the major brands. Controlling inventory will become paramount.
Putting a value to Callaway’s earnings has become increasingly difficult, at least when judged in reference to our Buy Rating. How do you value a three year earnings per share performance that goes $0.89 per share in 2007, $0.94 per share in 2008 and $0.92 per share in 2009? On one hand, despite all the work, reducing costs and improving the basis for margins has resulted in no growth in earnings per share. On the other hand, in a period where most discretionary consumer product companies are experiencing significant declines in revenues and earnings per share, producing flat earnings per share could be considered to be tremendous performance.
At this stage of the game, we have no idea how far up the stock can go. One whisper that things are improving for the consumer and everything remotely similar to Callaway (Consumer Discretionary) will take off like a shot and not stop for a couple years. So how far down can it go? We would judge tangible book value to serve as a reasonable floor for Callaway. That currently resides in the mid-$6’s.
So we will stay with our Buy Rating because we are looking at snow and ice out our window and we know that spring and the seasonally strongest period for the stock stands right in front of us. From the standpoint of price target, we are going to suspend our price target until we hear more from Callaway about their outlook for the year.
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.