Excerpts from Gilford Securities analyst Casey Alexander's recent note to clients on Callaway Golf (ELY):
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1. Risks to Achieving Price Target
In each report we are asked to provide the risks that we see that could impact the likelihood of the share price achieving our stated price target. Unfortunately, at this time several of those risks appear to be hitting Callaway in a domino sort of fashion. Based upon our last report, here was the list of the risks to achieving the stated price target of $22 per share:
Risks to Achieving the Price Target Include but are not limited to the following:
- Poor weather in key demographic regions
- Reduction in rounds played leading to decreased sales
- Failure to anticipate changing product trends in golf consumer preferences
- Inability to maintain improved gross margin initiatives
- Irrational competitive market resulting in lower average selling prices
- Poor general stock market conditions leading to P/E multiple compression
As we see it, several of these factors are coming into play in 2008, and to a degree which cannot be further ignored.
Failure to anticipate changing product trends in golf consumer preferences
TaylorMade and Ping appear to be winning the cash register at the moment in the U.S., particularly in the driver category. It appears that Callaway’s strategy of attempting to extend three key products (FT-i, FT-5 and X-20 irons) into second season sales at full price points is being met with consumer resistance. Thus a down year in total sales thus far, coupled with down market share in key categories is going to make the second quarter sell through period more challenging than usual.
Inability to maintain improved gross margin initiatives
What this means is that Callaway is going to have to rely on heavier discounting than usual to get key product categories moved through the channel. Therefore the company’s significant gross margin initiatives may not bear as much fruit as we previously considered. Domino number one falls into domino number two.
Irrational competitive market resulting in lower average selling prices
This is the third domino, and if this one gets knocked over, look out. Callaway is a market leader. Thus if Callaway makes a significant move on average selling prices, other competitors will be forced to respond. There is always the risk that they could respond irrationally, which could further damage the market for everyone.
2. The Good News
The good news is that we can’t see how this affects 2009. The changes Callaway has made are permanent. International continues to grow well. The branding strategy towards accessories and other has multiple opportunities in front of them. Therefore, until we see otherwise, we see no reason to change our outlook for 2009. It’s just that the seasonal trade in Callaway looks shot for 2008, and therefore a hold rating is more appropriate at this time.
We note that 2009 will usher in a new cycle of drivers and irons. Thus one of the problems of 2008 will be rapidly pushed into the rear view mirror in 2009. We would expect the i-Mix product to have a new set of heads available in 2009 also, perhaps lending better consumer acceptance of this new product line.
3. Updating Estimates After Tonight's Nights Call
We will update all of our estimates after tonight's EPS conference call. We see no reason to redo the whole table until we have the updated information. But we see it as prudent to go with a Hold rating given our current flow of information.
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.