Callaway Golf Back In The Fairway?

Apr.22.12 | About: Callaway Golf (ELY)

Callaway Golf (NYSE:ELY) has been hacking it in the rough since 2008 but a slew of recent news could help the stock come back into the fairway and in favor with investors.


Callaway has been without a seasoned golf executive at its helm since the passing of Ely Callaway in 2001. In February 2012, however, Callaway replaced its interim CEO with Chip Brewer, the former CEO at Adams Golf (NASDAQ:ADGF). Mr. Brewer has long history within the golf industry starting with his golf team days as an undergrad before he went on to get his MBA from Harvard University. After a short career in the paper industry in China, Mr. Brewer returned to the US and met Barney Adams on the golf course and secured the position of VP of Sales and Marketing at Adams Golf in 1998. He ascended to the role of CEO in 2002 when Adams Golf was facing a very difficult financial situation.

Adams Golf experienced a 20% drop in sales in 2002 as Mr. Brewer assumed the role of CEO. As well, the company had not been profitable since 1998. Mr. Brewer came in and made a series of critical and timely successful decisions to turn the company around. He hired a new VP of R&D and poured millions of dollars into turning out new products. He specifically focused on the redesign of the company's hybrid club line, making the clubs more accessible and popular for golfers of all age groups and skill. He also concentrated heavily on marketing within the Senior Tour, recruiting names like Tom Watson and Bernard Langer.

Top line sales growth quickly expanded 50% between 2002 - 2004 as Mr. Brewer introduced a new hybrid club line and his marketing strategy began to evolve. Further, Mr. Brewer managed to stay profitable throughout his tenure as CEO at Adams Golf and the company had an impressive CAGR in sales of 10.9% during the period of 2002-2011.

2002 Sales $37.92M
2011 Sales $96.5M
CAGR 10.9%
Click to enlarge


Callaway built its name in the golf industry off its Big Bertha woods in the 1990s. Throughout the latter half of the 2000s, however, the company lost market share due to its inferior R&D. Callaway was slow to develop new technologies and hasn't had a blockbuster product since the Big Bertha. Lagging product designs (and perhaps lack of deep pockets) has also led to some significant sponsor deflections, such as Graeme McDowell's jump from Callaway to Srixon in 2010.

Callaway has recently seen its most dramatic push to incorporate new golf technology into its product line since the Big Bertha. Specifically, Callaway's new RAZR Fit driver model is its first to incorporate adjustable weights and a rotating club face. Users can change the drivers' center of gravity and adjust the face angle using multiple settings to improve off-center ball contact. The new design has earned Callaway a top spot on Golf Digest's 2012 Hot List. Callaway introduced a new website feature as well where its RAZR driver can be customized (shaft, grip, length, color, etc) through its website - a first for the industry (check out the customizable options on Udesign). Callaway also has a new customizable Odyssey putter line with adjustable face plates that are first in the industry. Callaway seems to be catching up in the customization business and has a suite of new products that could be big hits in 2012.

Relative Valuation

There aren't many good comps for Callaway, but there is one notable comp out there, Mr. Brewer's former company, Adams Golf. It was announced in January that Adams was looking to be acquired - Mr. Brewer was still the CEO at the time. Prior to the announcement, Adams traded at a Price/Sales ratio of .52x and a Price/Book ratio of .79x. These are very close to where Callaway trades currently with a Price/Sales ratio of .49x and a Price/Book ratio of .85x. In mid March, Adidas agreed to buy Adams for $70M. Adams now trades at a Price/Sales ratio of .89x and a Price/Book ratio of 1.35x. The stock is being acquired at a 70% premium to where it traded back in the beginning of January. If Callaway trades up to higher multiples based off what Adams was acquired for the stock could be worth $8.75 - $11.00. The low price is based off ~50% of Adams' appreciation and the high price is based off ~100% of Adams' appreciation.

P/S Low .64x P/B Low 1.11x
P/S High .81x P/B High 1.40x
Price Low $8.75
Price High $11.00
Click to enlarge


Callaway may not be a takeover target at the moment, but if you can believe in the management turnaround story, then there is a lot of room for this stock to run up. Mr. Brewer is taking over the company after a few quarters of cost cutting (Global Operations Strategy) and a burst of new products and features that are being introduced. The stock has seen support in $5 range, so there is about 20% downside risk for a position in Callaway. If you are a long term investor and can pick the stock below $6.50 , then look for significant upside in the next year or two as the stock moves toward $8.75-$11.00. If management can significantly improve sales or reduce expenses, then the multiples could expand even further.

Look for any positive earnings surprises in Q1 or Q2 (warm weather + consumer confidence bodes well for the outdoor leisure sector) to be the catalyst to get this management turnaround story going.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ELY over the next 72 hours.