Callaway Golf: Raising 2008's Estimates, Lowering 2009's

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

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Callaway Golf: Raising Estimates for 2008, Lowering Estimates for 2009; Reiterate Hold Rating

1. Raising 2008 Revenue and EPS Estimates

We are raising our estimates for both revenues and EPS for 2008 back up. Clearly this has been a year with many challenges in the US market. Economic dislocation related to the consumer got the year off to a rocky start. This has been exacerbated by truly lousy weather in the Midwest. So how is Callaway managing to produce the growth promised for 2008? Our sources suggest that Callaway is bringing new product introductions up from 2009. We have heard that the Ft-9 driver will be introduced late in Q3, and that the next set of irons, the X-22 (we presume) will follow shortly thereafter. We also suspect that somewhere in this mix is a reduced share count from buybacks and the effect of the reduced share price on the option strike prices. We hope to be able to better model the share count after the quarter becomes official.

As a result, we are making the following changes in our revenue and earnings estimates: For Q2 2008 we are lowering our revenue estimate from $380MM to $366MM (pre-announced) and lowering our EPS estimate from $0.65 per share to $0.62 (pre-announced). For Q3 2008 we are raising our revenue estimate from $220MM to $225MM, but lowering our EPS estimate from $0.02 per share to ($0.00) per share (a nominal loss). The improved revenues are likely to be associated with reduced gross margins as Callaway clears the decks for the early new product introductions. Our Q4 2008 revenue estimate jumps from $140MM to $185MM as the impact from early new product introductions takes effect. This raises our Q4 EPS estimate from a loss of ($0.24) per share to a loss of ($0.14) per share).

The result of those changes means that our 2008 Full Year revenue estimate is going up from $1.106 billion to $1.142 bilion. Our 2008 Full Year EPS estimate rises from $1.01 per share to $1.08 per share.

The US market looks like it could produce a year where equipment sales come in down 7%-8%, which may not sound that bad until you judge it against 10 years of equipment sales that were +-2% regardless of what the economy was doing.

2. Reducing 2009 Revenue and EPS Estimates

We are now lowering our revenue and EPS estimates for 2009, since some poaching from 2009 is likely to take place with the accelerated new product introductions. We are reducing our 2009 revenue estimate from $1.196 billion to $1.180 billion. We are reducing our 2009 EPS estimate from $1.36 per share to $1.29 per share.

We still judge the US core golf equipment customer to be economically better off than most. This is backed up by the research from Pellucid Corp. and Edgehill Consulting, which stated in their annual 2007 State of the Industry report that a large majority of golfers come from households earning in excess of $50,000 per year. These are likely to be the first consumers to bounce back after this period of economic dislocation. After a year where equipment sales are down 7%-8%, we expect significant pent up demand for new clubs to emerge. This should be very good for Callaway Golf.

On top of the pent up demand building is the fact that in 2008 Callaway has been in the second selling season in two key product areas, drivers and irons. While that has led to market share losses in 2008, it has kept their new product powder dry in a year that sales were going to decline in those product areas no matter what they introduced. By accelerating the new club introductions into 2008, they are sacrificing some of their ability to take full advantage of 2009 when the pent up demand should become evident.

The upside of managing their earnings this way is that Callaway can say they are meeting the guidance they laid out for the year (an impressive performance for ANY consumer product company in this environment) and still offering attractive EPS growth for 2009 (approximately 20% EPS growth YOY).

3. Micromanaging the Recommendation

With the stock in the $13s, the opportunity to buy is developing. We paint ourselves guilty of micromanaging our recommendation, looking for the perfect spot to become more constructive with our rating. Our new concern is that Q3 will not meet expectations, although this is clearly a less important quarter than Q1 or Q2. Our work on the cyclicality of the shares suggests we should wait a little longer, although the low at $10.63 made on July 11th is a good bet to be the low for this cycle.

So we will maintain our Hold rating a little while longer, and we will decline to assign a price target until such time as we have more data from the 2007 Q2 EPS report. The Q2 report should be fascinating as we try to determine just how difficult this environment has been on Callaway Golf.

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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.

Comments

[Ames Tiedeman:]

A great product at least.

2008 Jul 27 07:35 PM