CALLAWAY GOLF CO ELY
February 18, 2010 - 11:02am EST by
jdr907
2010 2011
Price: 7.94 EPS -$0.26 $0.34
Shares Out. (in M): 84 P/E na 23.5x
Market Cap (in $M): 670 P/FCF na 15.9x
Net Debt (in $M): 0 EBIT -24 53
TEV ($): 565 TEV/EBIT na 10.7x

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Description

 

Callaway Golf presents an attractive investment combining a global brand, inexpensive cyclical play combined with a longer term secular growth story.  Callaway was written up back in 2006 when the stock was trading at $13.25 by rrjj52, as new management was coming in and had plans to restructure much of the business.  Management did a solid job cutting costs, and the business performed well through 2007, until the recession made a dent in consumer spending.  Callaway is the only independent golf company that is publicly traded, with strong brands including Callaway, Odyssey, Top-Flite and Ben Hogan.  They are the #2 golf brand with global sales of around $1 bn, behind Acushnet (Titleist, owned by Fortune Brands) at $1.4 bn. 

Callaway had a terrible 2009, posting revenue declines of 15% and Net Income swinging from a profit of $0.94 in 2008 to losing $0.26 / share.  The impact of the recession first started hitting the company during the 2H of 2008.  A combination of selling a highly discretionary product as consumers were tightening their belt, heavy discounting by competitors and a foreign exchange headwind (foreign sales make up ~50% of revenues) all combined to pressure numbers in 2009.  Combine this with a dilutive (~30% of shares outstanding) $140 million convertible preferred share offering in June to refinance a revolver where covenants were soon to be breached capped off a forgettable year.  The stock significantly underperformed its consumer discretionary peers, ending down 19% for 2009, and down 57% from Jan 1, 2008. 

ELY announced Q4 numbers in late January, and despite posting numbers that were marginally better than consensus combined with a conservative forecast for 2010 growth, the stock sold off another 5%.  Management expressed cautious optimism entering 2010, seeing early success in certain international markets, channel and corporate inventories at multi-year lows, a more benign competitive dynamic, an increase in leading consumer economic indicators and a strong product line-up awarded by Golf Digest.

Several growth drivers which I will go into more detail below should present ELY with strong growth potential in the next few years, providing significant upside to the stock price. 

1)     Cyclical recovery - pent up demand for drivers, irons, putters and attire from avid golfers ('avid' golfers make up 80% of ELY sales and are defined as golfers playing more than 8 rounds / year) - should begin to grow off depressed 2009 levels, where domestic revenue was down 14% and global constant currency total revenues were down 13%.  I do not expect the company will see anywhere near their 2007 revenue run-rate for a few years. Combined with this, the company expects a more benign competitive discounting environment, removing the severe gross margin pressure felt in 2009.  My base case calls for only 2% domestic growth and 3.7% constant currency global growth in 2010. 

2)     Cost savings initiatives have taken $70 million out of COGS through from 2007-2009, including $14 million in 2009.  The company has identified another $25-$45 million in the next 3 years; allowing the potential of peak gross margins approaching 50% in several years time (vs 36.8% in 2009 and 45% in 2008.

3)     Foreign exchange tailwind through 1H 2010, where 65% of annual sales are expected, should reverse at least 1/2 of the $42 mm in lost revenue and $26 mm of operating profit lost in 1H 2009 - even with the recent strengthening of the $ against the Euro.

4)     Secular Foreign growth opportunity in China, India, Latin America, Japan, Korea and other parts of SE Asia.  While golf is a mature industry in the US and many parts of Western Europe, growth in emerging markets, especially Asia is just beginning.  Golf was voted last year to be included in the 2016 Olympics, providing a strong opportunity to increase awareness, government and private spending on golf courses and ultimately accelerate international growth.  Companies with sports federations, such as India and China, are expected to make a strong showing through gov't training programs.  Currently, Callaway sells products in 110 countries. 

5)     New products such as uPro (golf course GPS device) and a renewed apparel strategy with a new partner.  In 2009, Callaway made the acquisition of uPro, a maker of GPS golf devices.  Callaway's former apparel contract with Ashworth ended in early 2009, and never made a significant dent in company financials.  2009 was a transition year out of the Ashworth contract, and in 2010 the Company started a new more beneficial partnership with Perry Ellis. 

6)     Dividend reinstatement - the company cut its dividend 85% on June 8th concurrent with the announcement of a dilutive convertible preferred equity offering.  The dividend went from $0.28 / year to $0.04 / year.  Management showed some committment to being a dividnedn paying company by sustaining a nominal dividend, and has indicated they have interest in returning to a more signficiant payout as the economy and the golf industry stabilize

7)     Patent lawsuit with Titleist on technology within the Pro VI balls which have around 36% market share.  Callaway sued Titleist a few years ago, alleging the Pro VI technology infringes on the patents they acquired with TopFlite.  A judge ruled in their favor initially, and an injunction was granted, however after appeal it was remanded down to a lower court and the injunction was lifted.  The case is scheduled to go back to trial in March, 2010.  This is a complete wildcard, but if they actually win, could offer upside of $1 / share.  No immediate time table for this. 

8)     Brand Equity - Potential Target

ELY currently trades at 5.4x 2010 EBITDA, 4.4x 2011 EBITDA, with a fully taxed 2010/11 FCF yield of 7%/10%.  Assuming base case scenarios where the company does not even approach the revenue run rate from 2008 until 2012, and normalized trading multiples, we believe the stock could be 50% higher in the next year.  Callaway's brands are premium in the golf industry, which has been hard hit by the recession, but unlike many other consumer stocks, has not seen signficant stock appreciation attributed to the future outlook of the business. 

2010 guidance calls for growth of 4-10%, with consensus expectations around 6%.  The company has assumed in their guidance that foreign currency will improve compared to 2009 providing 2-2.5% of growth; 4-5% of the increase in 2010 will come from international growth, and the balance will be from a slight recovery in domestic sales.  In addition, they expect a more positive retail environment with less discounting leading to higher gross margins and some increased contribution from uPlay and the new apparel contract.  They have guided for gross margins to improve from 37% in 2009 to 42-44% based on less discounting, forex, manufacturing leverage from higher volume and cost savings associated with gross margin cost savings initiatives.

 


(I apologize for the table formatting, have been struggling to get it to work) 

Callaway Capitalization

 

 

 

 

 

 

Stock Price

 

$7.94

 

 

 

 

Common Shares Out

 

64.5

 

 

 

 

Diluted Shares Out

 

19.9

 

 

 

 

Market Value (if converted)

 

$669.6

 

 

 

 

Debt

 

 -

 

 

 

 

Preferred Stock

 

140.0

 

 

 

 

Cash

 

104.7

 

 

 

 

Enterprise Value

 

$564.9

 

 

 

 

 

 

 

 

 

 

 

 

 

2008

2009

2010

2011

2012

 

 

 

 

 

 

 

US

 

$554.1

$475.7

$485.7

$505.9

$527.2

International

 

$563.0

$475.7

$523.5

$552.9

$586.8

Total

 

$1,117.1

$951.4

$1,009.2

$1,058.8

$1,114.0

y/y Growth

 

 

 

 

 

 

US

 

 

-14.1%

2.1%

4.2%

4.2%

International

 

 

-15.5%

10.1%

5.6%

6.1%

Total

 

 

-14.8%

6.1%

4.9%

5.2%

Gross Profit

 

$499.4

$350.0

$437.2

$471.5

$509.8

Gross Margin

 

44.7%

36.8%

43.3%

44.5%

45.8%

Operating Profit

 

$96.8

-$24.4

$52.6

$75.9

$102.1

% of Revenues

 

8.7%

-2.6%

5.2%

7.2%

9.2%

y/y Growth

 

 

NA

NA

44.3%

34.6%

EBITDA

 

$141.1

$25.1

$104.0

$128.2

$155.3

% of Revenues

 

12.6%

2.6%

10.3%

12.1%

13.9%

y/y Growth

 

 

-82.2%

314.1%

23.3%

21.2%

Diluted EPS

 

 

-0.26

$0.34

$0.56

$0.81

y/y Growth

 

 

 

 

65.7%

44.6%

FCF

 

$0.00

-$0.11

$0.50

$0.66

$0.84

y/y Growth

 

 

 

 

32.8%

26.5%

 

 

 

 

 

 

 

EV / EBITDA

 

4.0x

22.5x

5.4x

4.4x

3.6x

EV / EBIT

 

5.8x

-23.2x

10.7x

7.4x

5.5x

P / E

 

 

 

23.5x

14.2x

9.8x

P / E (net of cash)

 

 

 

19.8x

11.9x

8.3x

FCF Yield

 

 

-1.4%

6.3%

8.3%

10.5%

FCF Yield (Net of Cash)

 

 

-1.7%

7.4%

9.9%

12.5%

 

 

 

 

 


Company Overview

Callaway has a top-three market share in all major equipment categories - woods, irons, putters and balls.  Over the past few years, Taylor Made has had a strong push into the equipment segment, and taken market share, mostly from other competitors while Callaway has held its own.  They have also been partly responsible for the aggressive discounting in the retail channel, devastating company gross margins during 2009.  During the turmoil of the last year, the market share trend actually reversed, Callaway gained market share in woods (+2%), irons (+1%) and putters (+1%), while losing about 100 bps in share in the ball category.  Callaway, along with its Odyssey brand, are two of the leading names in the industry and the products have typically sold at a premium.  Key competitors in each of the markets are:

 

Woods

Irons

Putters

Balls

1)

TaylorMade (Addidas)

Callaway

Odyssey (ELY)

Titleist

2)

Callaway

TaylorMade

Ping

Bridgestone

3)

Ping (family owned)

Ping

Titleist (FB)

Callaway/TopFlite

Golf equipment relies heavily on new product cycles, typically introduced annually.  R&D, has remained a focus of Callaway even during the downturn.  They historically have spent between 3-3.5% of revenues on R&D.  Callaway offers new drivers, typically annually, at various price points between $299 and $499.  This years new offerings include a range of new Odyssey putters, the FT-9, Diablo Edge Tour for woods and Diablo Edge irons.  Odyssey, has over 30% share of the putter market, 10% above its nearest competitor.  Callaway has over 3,000 patents for golf equipment.   

In 2009, Callaway did not introduce any new balls at the high end, while Titleist did.  During the year, they lost an incremental 1.5% of market share to Titleist (also owns Pinnacle), who has roughly 60% of the market already.  The ball category has been hovering around breakeven, but with cost cuts around ball manufacturing, as well as two new balls introduced at the high end in In January, 2010, (in the the i(z) and i(s) line), they should gain back market share and have positive margins.  From a new product perspective, as well as commentary around the PGA Show held Feb 1 in Orlando, there are positive signs at least in terms of competitive positioning in the market during 2010.   In the latest Golf Digest, Callaway received 10 gold and 5 silver metals for its 2010 lineup, 3 more than its closest competitor.  Callaway had a strong presence at the recent golf show, for both equipment and apparel - with the new Perry Ellis line.  Two big players in the market did not make an appearance at all this year - Nike (b/c of Tiger?) and Taylor Made. 

Sponsorship

Callaway has significant brand equity through sponsorship of tour professionals.  Their roster includes Phil Mickelson, Ernie Els, Stuart Appleby, Arnold Palmer, Annika Sorenstam among others.  Payment of these contracts are typically tied to tour success and re-negotiated annually. To the question of Tiger, and his recent woes - the company does not believe that taking Nike's major sponsor away from the game for an extended period of time is a positive competitively for them.  Viewership of PGA tournaments where Tiger does not play have been down in excess of 50%.  So while, they don't expect to be hurt by fewer players, Tiger is an overwhelming positive for the sport, bringing new people into it. Tomorrow, Tiger is apparently going to announce his return to the sport.   

Revenue Breakdown

Callaway generates 50% of its revenue from the US market, and 50% internationally.  The international market is growing significantly faster than the US, which is essentially mature.  Over the past few decades, the golf industry in the US grew rapidly, building excess supply of courses and equipment sales peaking between 2005-2007.  Despite significantly lower spending, golfers continued to play through the recession.  In previous recessionary periods, golf sales have troughed around the same time that the recession ended. In 2009, rounds of golf played in the US were flat at 488 million (they have essentially been at this level since 2000), and the National Golf Federation projects another year of flat rounds, despite fewer courses in 2010.  2009 had a record number of closures at 140, compared to 32 in the 2001 last recession.  Core golfers in the US (defined as >8 rounds / year) were 16.6 million, with 12.7 million occasional golfers. 

International revenue is derived from over 110 countries.  Japan makes up 17% of revenues, other Asia including Korea makes up 8%, Europe at 14% and the Rest of World at 11%.  While the Japanese market is fundamentally mature with 9% of the population playing golf  - similar to the US 10%  penetration) Callaway continues to grow in those markets through new product introductions and market share growth. 

 

FY Ended  December 31, 2008 2009 1Q10E 2Q10E 3Q10E 4Q10E 2010 2011 2012
Revenue by Region
   



     
US
$554.1 $475.7            144.7         165.4           96.6           79.0 $485.7 $505.9 $527.2
Europe
           190.9            134.6              47.8           45.1           26.6           21.0        140.5        146.5        153.4
Japan 
           166.6            162.8              52.9           43.3           31.6           50.5        178.4        187.8        196.8
Rest of Asia
            79.9             77.0              20.6           23.3           23.0           19.6         86.6         92.6        100.2
Other
           125.6            101.4              31.6           43.4           21.9           21.1        118.0        126.1        136.5
Total
$1,117.3 $950.9 $297.7 $320.5 $199.7 $191.3 $1,009.2 $1,058.8 $1,114.0


   



     
Country Breakdown
   



     
US
49.6% 50.0% 48.6% 51.6% 48.3% 41.3% 48.1% 47.8% 47.3%
Europe
17.1% 14.2% 16.1% 14.1% 13.3% 11.0% 13.9% 13.8% 13.8%
Japan 
14.9% 17.1% 17.8% 13.5% 15.8% 26.4% 17.7% 17.7% 17.7%
Rest of Asia
7.2% 8.1% 6.9% 7.3% 11.5% 10.2% 8.6% 8.7% 9.0%
Other
11.2% 10.7% 10.6% 13.5% 11.0% 11.1% 11.7% 11.9% 12.3%
Total
100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


   



     
Growth by Region
   



     
US
-7.3% -14.1% 2.4% 1.0% 2.8% 3.1% 2.1% 4.2% 4.2%
Europe
-1.2% -29.5% 11.3% 5.8% -1.9% -4.2% 4.4% 4.3% 4.7%
Japan 
38.8% -2.3% 11.9% 16.5% 8.3% 2.9% 9.6% 5.2% 4.8%
Rest of Asia
-6.8% -3.7% 24.4% 10.3% 9.7% 7.6% 12.5% 6.9% 8.2%
Other
-1.6% -19.3% 33.4% 14.8% 10.3% 5.3% 16.4% 6.9% 8.2%
Total
-0.6% -14.9% 9.5% 6.1% 4.6% 2.9% 6.1% 4.9% 5.2%


   



     
Product % of Sales
   



     
Woods
24.0% 23.5% 29.6% 24.9% 18.4% 17.3% 23.6% 23.4% 23.3%
Irons
27.6% 24.6% 24.2% 24.1% 26.2% 25.6% 24.8% 24.8% 24.8%
Putters
9.1% 10.3% 10.1% 8.8% 9.1% 13.7% 10.2% 10.2% 10.2%
Golf Balls
20.0% 19.0% 17.2% 19.2% 21.3% 18.9% 19.0% 18.7% 18.5%
Other
19.3% 22.5% 18.9% 23.1% 25.0% 24.4% 22.5% 22.9% 23.3%
Total
100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
                     

Golf sales are highly seasonal, with 1H providing between 60-65% of revenues and the majority of profits.   Distribution of products varies by market, however domestically, sales are distributed broadly through golf specialty (35%), Green Grass (30%), Sporting Goods (20%), Mass merchants (10%) and Corporate (5%). 

 

1)  Cyclical recovery

Economic indicators in the US, making up 50% of revenues, have improved significantly on a y/y basis.  Q1 2009, consumers remained in a state of panic, with consumer sentiment indexes hitting all time lows.   The U. of Michigan Consumer Sentiment Index had a January reading of 61.2, Feb of 56.3 and March of 57.3, while January 2010 had a reading of 74.4, a 21% improvement.  The Conference Board Consumer Confidence Index saw lows of between 25 and 37 in Q1 2009 vs January 2010 reading of 55.90.  Clearly there are still serious issues in the US economy, but given the recent strength of retail sales, consumer confidence and other leading indicators, one can surmise that in Q1 2010, the consumer is in better shape than the beginning of 2009.  While leading indicators have been tracking in the right direction for 9 months, unemployment remains stubbornly high at 10%, while in Q1 2008, it was around 8%.  With 1H making up over 65% of revenues historically, the company should see a benefit of easier comps in 1H 2010.  However, from a product standpoint, the company has been seeing consumers purchasing down to lower price points; ie: instead of purchasing the new $399 driver, they are getting the $299 driver.  I do not expect this behavior to change in the near term.  Similar to what we have seen in retail sales - including flat screen TVs, other electronics and other sporting goods, there is pent-up demand for discretionary products that consumers have not purchased in almost two years.  

During the Q1 call on January 26, management had cautious optimism about the economic recovery as it relates to their business.  Pre-books of new products in January have been in-line with expectations, while orders for immediate delivery have been heavier than in 2009, reflecting retail conservatism around inventory build.  The Sun Belt so far has show early signs of improvement, despite varied weather.  Retailers have lean inventory levels, after a year of reducing the amount of inventory purchased.  This may represent an opportunity later in the year, as retailers become more confident in the pace of the recession and build inventories - but at worst it should be neutral this year.  No inventory refresh has been baked into the company's guidance. 

International revenues have been in a cyclical upswing since Q4, where they grew 21% on a currency neutral basis in Q4, with US revenues down 14%.  Several long-term drivers will allow the company to continue to post robust international revenue growth for the next few years.  It is important to note that Callaway actually derives higher gross margins from its international operations - typically selling more expensive and higher end items abroad.  They target the higher end consumer, not the mass market and tend to see less promotional discounting. 

Discounting of leading brands at retail in an effort to spur demand in 2009 had a significant impact on gross margins which for the full year came in at 36.8%, down from 44.7% in 2008.  TaylorMade was one of the larger aggressors of discounting.  In many cases, discounts were - buy a driver, get one free fairway woods - offering $150 to $200 of value to the consumer.  As smaller, more marginal brands lost shelf space to the major brands in 2009, Callaway was able to gain market share as mentioned before.   Comments from the Q1 call also point to a more rational pricing environment, while obviously still early in the year.  In addition, Callaway inventory levels at 12/31 were $219 mm, down from $257 mm a year ago, and the lowest level in 5 years.

Callaway had a strong product lineup in the market in 2009, and it seems that they again will show technological strength in 2010 (read comments above about lineup).  This will provide somewhat of a tailwind if the industry stabilizes and begins to show growth in 2010.  Lastly, Dicks Sporting Goods results indicated that consumers are beginning to come back to retail to purchase sports equipment. 

 

2) Cost Savings - Gross Margin Expansion

Aside from gross margin expansion coming from firming of the promotional market, the company has cut costs aggressively over the past 3 years, in an effort to make the company and supply chain more efficient.  From 2007-2009, the company cut $70 million out of its fixed costs, and have identified another $25-$45 to eliminate from 2010 - 2012, with about 1/3 of that coming in 2010.  Much of the additional cost savings is both from outsourcing manufacturing and moving some of it offshore.  Currently, they manufacture around ½ of the products internally.  Other areas of cost cutting include logistics, warehousing, international operations and distribution.  Due to these initiatives, lead-times historically have been in the 145 to 175 range, and now are down to 45 days. Given their track record in the past 3 years of cost cutting on schedule, I am giving them credit for the low end of their cost cuts in my projections. This should obviously drive increased operating leverage as revenues ramp.  

 

3) Foreign Exchange

The company was hard hit by currency exchange in 2009.  Specifically, the USD strength against the Euro, GBP, and secondarily the CAD, AUD and Korean Won provided a significant headwind in 1H 2009 where  revenues were impacted negatively by $42 million - about 7% of 1H revenues.   Assuming current currency levels through 1H, the company would gain back about ½ of what they lost in 1H 2009 or about $21 million.  Typically, a $1 move in revenues due to currency, will impact operating margin by $0.65.  Currency effectively hurt 1H 2009 operating income by 25%, and can be a tailwind in 1H 2010 by about 14%.  The back half of 2009 was less impacted by currency, and actually saw a slight benefit.  I am modeling for a flat currency environment in 2H 2010 and going forward.  The company typically does not hedge its FX risk.   I am assuming a USD/Euro of 1.37, USD/GBP of 1.58 and Yen/USD of 90. 

 

4) Foreign Growth Opportunity

The international growth opportunity is the secular long term growth story for Callaway.  As mentioned previously, international revenues represent about 50% of total revenues.  European revenue makes up 14%, Japan 17%, Rest of Asia including Korea is 8% and 'Other' including Australia, South Africa, Canada, Latin America make up the remaining 11%.  Over the next three, years, management believes it can comprise 60% of revenues.  Using my conservative projections, after three years, I have international revenues at 52% of revenues, and int'l growing at a 3 year CAGR of 7%.  If management's aggressive comments (which I take with a grain of salt) are correct, assuming no growth in US revenue (which is unrealistic), International would be growing at a 3 year CAGR of 15.5%.  Total 2012 international revenues would be $733 bn vs. my estimate of $578 billion.  This is simply illustrative to show the potential for international growth vs. the conservative estimates in my base case. 

In October the International Olympic Committee selected golf to be included in the 2016 summer Olympics.  This could potentially create a large tailwind through 2016 for international government and private spending around teaching and training golf, as well as buidling new golf courses.  This is especially true for those countries like India and China where the Olympics represent an important public forum to represent their nation.  China has already hired the Australian PGA to train Chinese pros in order to bring them up to worldwide caliber.  In addition, well known athletes have indicated they will play in the Olympics, driving more awareness and interest in the sport.  The world's 15 top layers would automatically qualify regardless of the number of players from a given country, and then a maximum of two players from each country would be allowed to compete.   If you simply think about the 4.7 billion people that watch the Olympics vs the few million that watch the PGA, clearly a much larger demographic will be exposed to the sport, including a younger group than the avg golfer. 

It is estimated that there are currently between 2-3 million golfers in China, and the sport is growing at 50% per year.  3.7 mm golfers are expected by y/e 2010, and 500-1000 new golf courses are expected to be added over the next few years to the roughly 500 that exist now. 

The company will be introducing the Callaway brand to India on February 15th, with products beginning to hit the shelves in mid March.  Currently, there are about 500,000 golfers in India, with 250 golf courses in operation and 50 more being built.  Management ran through a scenario during the recent call framing the market opportunity for India.  If 2% of the population play golf (vs 10% in the US), and spend 1/3 of the average US spend ($123/yr), then the market would be $1.2 billion.  The professional Indian domestic golf market is beginning to take shape as well, with prize money growing from around $700k a few years back to close to $2 million in 2010.  Top international golfers have recently been playing in foreign sponsored tournaments in India, attracted by increasing sponsorship money.  In addition, big names like Greg Norman, Nick Faldo, Gary Player and Jack Nicklaus have contracted with developers to design signature golf course in India.   India actually has a long history of golf, through its British heritage - the second-oldest golf course in the world is actually located in Calcutta and was built in 1829.  Currently, resort and property developers are looking at golf as a new lure for international tourism leading to a course building boom.  Callaway is teaming up with the #1 domestic Indian golfer - Jeev Mikah Singh as its brand ambassador to help get the sales effort off the ground.  Industry analysts believe the Indian golf market has been growing 25-30% a year for the past three years, and is now hitting a growth inflection point.  Callaway plans to market from multi-brand outlets beginning March 1, and roll out to exclusive stores in 2H 2010.  As noted above, Callaway typically derives higher margins from international operations and India should perform in a similar manner.  They are planning on selling FT1Z driver for north of $500, and sets of clubs ranging from $200 to several thousand $s. 

The Japanese market is somewhat unique.  Penetration of golfers is 9%, vs 10% in the United States, but Callaway is still growing very rapidly there, primarily from market share gains.  In 2008 on a constant currency basis, Japanese revenues were up 22%, and down 12% in 2009.  I am modeling for a tepid recovery over the next few years of 5-6% growth. 

In Latin America, Callaway currently sells into Mexico, however not into most countries in South America.  The 2016 Olympics will be held in Brazil, and currently Callaway does not sell product there.  This could be a large potential market for the company in the future. 

Europe has been a slower growth market than Asia.  Ireland and UK represent a large piece of the 14% of revenue represented by Europe, but not most of the growth.  Revenue was down 4% on a constant currency basis in 2008 and down 18% in 2009.  I am not modeling significant growth for the European markets, although given the low penetration rates in most countries, the potential exists.  Western Europe is a mixed bag of interest in golf.  Penetration in certain countries such as France and Germany remains low, while Ireland, UK, Denmark and Scandinavian countries have a more mature market.  Eastern Europe has seen the number of golf courses triple to 135 in the last decade, and the sport is just beginning to evolve there.  

5) Perry Ellis Contract

Callaway through 2009 had a apparel deal with Ashworth, where it was a pure royalty arrangement and Callaway had very little control of the product or distribution.  This contracted ended in 2009, and they signed a new contract with Perry Ellis.  2009 was a transition year as they ramped down Ashworth and began production and development with Perry Ellis.  2010 will present the first full year of Callaway branded Perry Ellis apparel.  The full P/L will flow through Callaway's income statement now, showing a lower margin than the previous contract which was strictly royalties, but larger potential for margin dollars.  The pure margin falling off in 2009 also added to the decline in gross margins.  The company has discussed that a good data point to size the opportunity is TaylorMade's apparel business, which is roughly $200 million in apparel and $100 mm in footwear annually.  Currently, Callaway does little in both of these categories, but has the potential to leverage its brand equity and distribution channels.  This deal will allow Callaway to be more involved, including selling to the golf clubs and other distribution channels that it has relationships with - which was not the case under the Ashworth contract. 

uPlay is a Golf GPS device product, that Callaway purchased on December 31, 2008 for roughly $10 mm.  They offer two products uPlay for $399 and Go for $299; both offer course libraries, GPS ball positioning, aerial topography of the course etc.  The higher end model offers additional features like green contours and more aerial details.  They have seen good traction, especially through the holiday gift giving period.  However, I remain skeptical of the long tem growth opportunity in this business given the advent of smartphone software that essentially has most of the functionality of uPlay.  Like the PND market though, there is a niche market for avid golfers who prefer the dedicated device for golf, and easier user interface.  I have not baked in significant revenues from uPlay going forward. 

6)  Dividend Reinstatement

The company cut its dividend concurrent with the Preferred offering in an effort to save cash.  At the time, the dividend was $0.28 / year - or a 6% yield last June.  The dividend was cut to a nominal $0.04 / year.   The company has commented that at the right time, they would likely reinstate a higher dividend - and I think by not completely eliminating the dividend they have in effect stated their commitment to having one.   This is likely more of a 2011 event. 

7)  Golf ball patent lawsuit resolution

A favorable outcome with Acushnet regarding the patent lawsuit over the Titleist Pro VI would be a boost to the stock, and could create a windfall of up to $70 million.  The case will be heard by the district court again in March 2010.  Obviously there is no way to handicap the outcome.  

8)  Brand Equity & Potential Target

Callaway's brand is one of the golf industry's premier names, in the company of Titleist, Taylormade, Nike and Ping.  There is clear value to a larger conglomerate (Addidas, Nike?) to owning the Callaway brand, market share and history of R&D expertise, among other things.  While this is not core to the thesis, given the relative valuation, market cap and value that Callaway brings, I would not be surprised to see them as a takeout candidate down the road.

Valuation

Based upon these scenarios, my bull/base/bear case are as follows.  All valuation metrics are shown on an 'if converted basis' to take into consideration dilution from preferred offering.  

The company currently trades at 5.4x 2010 EBITDA in my base case scenario, with a fully taxed 7.4% FCF yield.  Looking out to 2011 it is trading at 4.4x EBITDA, 12x EPS with a 10% FCF yield.  I have backed out cash from the analysis given the almost nil yield they are getting on it. 

 

Bull

 

Base

 

Bear

Revenues

2010

2011

 

2010

2011

 

2010

2011

US

$641.6

$684.4

 

$485.7

$505.9

 

$618.6

$638.3

International

      395.7

     436.1

 

     523.5

     552.9

 

      376.6

      393.0

Total

$1,037.3

$1,120.4

 

$1,009.2

$1,058.8

 

$995.2

$1,031.3

y/y Growth

 

 

 

 

 

 

 

 

US

34.9%

6.7%

 

2.1%

4.2%

 

30.0%

3.2%

International

-16.8%

10.2%

 

10.1%

5.6%

 

-20.8%

4.3%

Total

9.0%

8.0%

 

6.1%

4.9%

 

4.6%

3.6%

 

 

 

 

 

 

 

 

 

Gross Profit

$454.4

$509.0

 

$437.2

$471.5

 

$428.6

$454.7

Gross Margin

43.8%

45.4%

 

43.3%

44.5%

 

43.1%

44.1%

 

 

 

 

 

 

 

 

 

Operating Profit

$61.3

$95.2

 

$52.6

$75.9

 

$48.2

$67.2

% of Revenues

5.9%

8.5%

 

5.1%

7.2%

 

4.6%

6.5%

y/y Growth

NA

55.1%

 

NA

44.3%

 

NA

39.6%

 

 

 

 

 

 

 

 

 

EBITDA

$112.8

$147.5

 

$104.0

$128.2

 

$99.6

$119.5

% of Revenues

10.9%

13.2%

 

10.3%

12.1%

 

10.0%

11.6%

y/y Growth

349.1%

30.8%

 

314.1%

23.3%

 

296.6%

20.1%

 

 

 

 

 

 

 

 

 

Diluted EPS

$0.42

$0.75

 

$0.34

$0.56

 

$0.30

$0.48

y/y Growth

 

76.4%

 

 

65.7%

 

 

61.3%

 

 

 

 

 

 

 

 

 

FCF

$0.56

$0.77

 

$0.50

$0.66

 

$0.47

$0.61

y/y Growth

 

39.0%

 

 

32.8%

 

 

31.6%

 

 

 

 

 

 

 

 

 

EV / EBITDA

5.0x

3.8x

 

5.4x

4.4x

 

5.7x

4.7x

EV / EBIT

9.2x

5.9x

 

10.7x

7.4x

 

11.7x

8.4x

P / E

18.8x

10.7x

 

23.5x

14.2x

 

26.8x

16.6x

P / E (net of cash)

15.9x

9.0x

 

19.8x

11.9x

 

22.6x

14.0x

FCF Yield

7.0%

9.7%

 

6.3%

8.3%

 

5.9%

7.7%

FCF Yield (Net of Cash)

8.3%

11.5%

 

7.4%

9.9%

 

6.9%

9.1%

Pure competitors are hard to find in this space - so I have looked at companies with strong brands, and are present in the sports equipment or apparel industry.  I think the appropriate way to view the numbers is on 2011 or 2012 ( I have used 2011), based on the time it takes for the cyclical recovery to take shape.  Assuming my base case numbers, and applying competitor multiples, the stock should be trading 60% higher than it currently is on an EV/EBITDA basis.   Applying a 2012 EPS estimate of $0.75, showing the earnings potential of the company to a average multiple of 15x, gets me north of $11 / share, or about 40% higher than the current price.  This story will take some time to unfold, but given the above mentioned catalysts, the trough valuation and positive secular and cyclical story ahead, patient investors can find a good entry point in the name. 

In the downside scenario, the share price is backstopped both by its current valuation, and by book value / share.  Assuming the bear case scenario and a 2011 EPS comp multiple, the stock could dip to the $7 level, or about 15% below current prices.  Additionally, downside is backstopped by a book value / Share of over $ 8 / share.  If you back out intangibles/goodwill and assume full conversion of preferred stock, you get to $6 / share - 25% lower. 

Competitive Universe

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EV / EBITDA

 

P/E

 

 

 

 

Price

 

Market Cap

 

Ent Value

 

2010

2011

 

2010

2011

 

Div Yield

Adidas

 

€ 36.75

 

€ 7,688.7

 

€ 10,035.7

 

12.7x

9.0x

 

28.1x

15.4x

 

na

Brunswick Corp.

 

$12.28

 

$1,084.3

 

$1,408.6

 

59.6x

6.3x

 

NA

NA

 

0.79%

Columbia Sportsware

 

$44.70

 

$1,510.7

 

$1,101.3

 

8.5x

7.9x

 

21.3x

18.6x

 

1.69%

Fortune Brands

 

$42.79

 

$6,433.2

 

$10,493.9

 

9.8x

8.9x

 

15.8x

12.9x

 

2.34%

Life Time Fitness, Inc.

 

$26.60

 

$1,100.8

 

$1,776.0

 

6.8x

5.9x

 

13.8x

12.5x

 

0.00%

Mizuno

 

¥408.00

 

¥54,219.6

 

¥58,489.6

 

10.9x

9.6x

 

26.4x

21.6x

 

1.86%

Nike

 

$64.37

 

$31,719.1

 

$28,279.7

 

10.2x

9.2x

 

17.5x

15.6x

 

1.57%

Polaris Industries, Inc.

 

$44.08

 

$1,441.4

 

$1,501.2

 

6.3x

5.7x

 

13.4x

12.3x

 

3.58%

Smith & Wesson Corp.

 

$4.25

 

$253.9

 

$293.6

 

5.4x

5.0x

 

11.4x

10.5x

 

0.00%

Timberland

 

$18.06

 

$999.6

 

$709.7

 

5.9x

NA

 

17.1x

15.5x

 

0.00%

Under Armor

 

$25.68

 

$1,288.3

 

$1,121.2

 

9.2x

8.0x

 

24.4x

21.4x

 

0.00%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Min

 

5.4x

5.0x

 

11.4x

10.5x

 

 

 

 

 

 

 

 

Mean

 

13.2x

7.5x

 

18.9x

15.6x

 

 

 

 

 

 

 

 

Median

 

9.2x

7.9x

 

17.3x

15.5x

 

 

 

 

 

 

 

 

Max

 

59.6x

9.6x

 

28.1x

21.6x

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ELY - Bull

 

$7.94

 

$669.6

 

$564.9

 

5.0x

3.8x

 

18.8x

10.7x

 

0.50%

ELY - Base

 

$7.94

 

$669.6

 

$564.9

 

5.4x

4.4x

 

23.5x

14.2x

 

0.50%

ELY - Bear

 

$7.94

 

$669.6

 

$564.9

 

5.7x

4.7x

 

26.8x

16.6x

 

0.50%

 

Valuation at Median Comp Multiples

 

 

 

 

EV / EBITDA

 

P/E

 

 

 

 

 

 

 

 

2010

2011

 

2010

2011

 

 

 

 

 

 

 

 

9.2x

7.9x

 

17.3x

15.5x

 

 

 

 

 

 

 

 

 

 

 

 

 

ELY - Bull

 

 

 

 

 

 

 

$13.48

$17.59

 

$7.30

$11.54

ELY - Base

 

 

 

 

 

 

 

$12.52

$13.29

 

$5.85

$8.69

ELY - Bear

 

 

 

 

 

 

 

$12.05

$14.53

 

$5.13

$7.41

 

 

 

 

 

 

 

 

 

 

 

 

 

% Upside / Downside

 

 

 

 

 

 

 

 

 

 

 

 

ELY - Bull

 

 

 

 

 

 

 

69.7%

121.6%

 

-8.1%

45.4%

ELY - Base

 

 

 

 

 

 

 

57.7%

67.4%

 

-26.3%

9.4%

ELY - Bear

 

 

 

 

 

 

 

51.7%

83.0%

 

-35.4%

-6.7%

 

Risks

Of course I could be wrong in my analysis and outlook for the golf industry.  Below are a few points which could lead the thesis in the wrong direction. 

One of the key industry problems that plagued the company in 2009 was competitive discounting.  If consumer demand remained weak, competitors could resort again to price discounting to drive store traffic, thus driving down gross margins.  This is a real risk, one they have not seen yet in early 2010, but if the sales season does not come together as expected, the industry may resort to this.  This would cap any upside in the name, lead to lower gross margins and slower revenue growth. 

Secondly, and more obviously, a double dip recession or much slower pace of economic recovery could put a limit on the amount consumers are willing to purchase for sports equipment. 

There is a belief that consumers have permanently changed the way the purchase consumer discretionary items now, always looking for discounts.  While this may be the case in the next year or two, I don't believe there is a permanent  change, and do think that consumer will return to buying premium products.  However, if I am wrong, and consumers permanently change their purchasing behavior, and continue to purchase lower end products, revenue growth will be constricted and it will be harder to return to the 45+% gross margin levels. 

There is always the possibility of a destruction of brand image, either through poor R&D and product development, or from moral issues from the individuals they are sponsoring (ala Tiger).  This is unquantifiable. 

If the US $ strengthens through the year, leading to more difficult foreign currency translation, the company would continue to suffer, and revenue growth would be hampered. 

 

Catalyst

1)     Cyclical recovery - pent up demand for drivers, irons, putters and attire from avid golfers should begin to grow off depressed 2009 levels

2)     Cost savings initiatives will remove $25-$45 million in the next 3 years; allowing the potential of peak gross margins approaching 50% in several years time 

3)     Foreign exchange tailwind through 1H 2010, where 65% of annual sales are expected

4)     Secular Foreign growth opportunity in China, India, Latin America, Japan, Korea and other parts of SE Asia. 

5)     New products such as uPro (golf course GPS device) and a renewed apparel strategy with Perry Ellis take shape

6)     Dividend reinstatement 

7)     Patent lawsuit with Titleist resolution

8)     Brand Equity - Potential Target

    sort by    

    Description

     

    Callaway Golf presents an attractive investment combining a global brand, inexpensive cyclical play combined with a longer term secular growth story.  Callaway was written up back in 2006 when the stock was trading at $13.25 by rrjj52, as new management was coming in and had plans to restructure much of the business.  Management did a solid job cutting costs, and the business performed well through 2007, until the recession made a dent in consumer spending.  Callaway is the only independent golf company that is publicly traded, with strong brands including Callaway, Odyssey, Top-Flite and Ben Hogan.  They are the #2 golf brand with global sales of around $1 bn, behind Acushnet (Titleist, owned by Fortune Brands) at $1.4 bn. 

    Callaway had a terrible 2009, posting revenue declines of 15% and Net Income swinging from a profit of $0.94 in 2008 to losing $0.26 / share.  The impact of the recession first started hitting the company during the 2H of 2008.  A combination of selling a highly discretionary product as consumers were tightening their belt, heavy discounting by competitors and a foreign exchange headwind (foreign sales make up ~50% of revenues) all combined to pressure numbers in 2009.  Combine this with a dilutive (~30% of shares outstanding) $140 million convertible preferred share offering in June to refinance a revolver where covenants were soon to be breached capped off a forgettable year.  The stock significantly underperformed its consumer discretionary peers, ending down 19% for 2009, and down 57% from Jan 1, 2008. 

    ELY announced Q4 numbers in late January, and despite posting numbers that were marginally better than consensus combined with a conservative forecast for 2010 growth, the stock sold off another 5%.  Management expressed cautious optimism entering 2010, seeing early success in certain international markets, channel and corporate inventories at multi-year lows, a more benign competitive dynamic, an increase in leading consumer economic indicators and a strong product line-up awarded by Golf Digest.

    Several growth drivers which I will go into more detail below should present ELY with strong growth potential in the next few years, providing significant upside to the stock price. 

    1)     Cyclical recovery - pent up demand for drivers, irons, putters and attire from avid golfers ('avid' golfers make up 80% of ELY sales and are defined as golfers playing more than 8 rounds / year) - should begin to grow off depressed 2009 levels, where domestic revenue was down 14% and global constant currency total revenues were down 13%.  I do not expect the company will see anywhere near their 2007 revenue run-rate for a few years. Combined with this, the company expects a more benign competitive discounting environment, removing the severe gross margin pressure felt in 2009.  My base case calls for only 2% domestic growth and 3.7% constant currency global growth in 2010. 

    2)     Cost savings initiatives have taken $70 million out of COGS through from 2007-2009, including $14 million in 2009.  The company has identified another $25-$45 million in the next 3 years; allowing the potential of peak gross margins approaching 50% in several years time (vs 36.8% in 2009 and 45% in 2008.

    3)     Foreign exchange tailwind through 1H 2010, where 65% of annual sales are expected, should reverse at least 1/2 of the $42 mm in lost revenue and $26 mm of operating profit lost in 1H 2009 - even with the recent strengthening of the $ against the Euro.

    4)     Secular Foreign growth opportunity in China, India, Latin America, Japan, Korea and other parts of SE Asia.  While golf is a mature industry in the US and many parts of Western Europe, growth in emerging markets, especially Asia is just beginning.  Golf was voted last year to be included in the 2016 Olympics, providing a strong opportunity to increase awareness, government and private spending on golf courses and ultimately accelerate international growth.  Companies with sports federations, such as India and China, are expected to make a strong showing through gov't training programs.  Currently, Callaway sells products in 110 countries. 

    5)     New products such as uPro (golf course GPS device) and a renewed apparel strategy with a new partner.  In 2009, Callaway made the acquisition of uPro, a maker of GPS golf devices.  Callaway's former apparel contract with Ashworth ended in early 2009, and never made a significant dent in company financials.  2009 was a transition year out of the Ashworth contract, and in 2010 the Company started a new more beneficial partnership with Perry Ellis. 

    6)     Dividend reinstatement - the company cut its dividend 85% on June 8th concurrent with the announcement of a dilutive convertible preferred equity offering.  The dividend went from $0.28 / year to $0.04 / year.  Management showed some committment to being a dividnedn paying company by sustaining a nominal dividend, and has indicated they have interest in returning to a more signficiant payout as the economy and the golf industry stabilize

    7)     Patent lawsuit with Titleist on technology within the Pro VI balls which have around 36% market share.  Callaway sued Titleist a few years ago, alleging the Pro VI technology infringes on the patents they acquired with TopFlite.  A judge ruled in their favor initially, and an injunction was granted, however after appeal it was remanded down to a lower court and the injunction was lifted.  The case is scheduled to go back to trial in March, 2010.  This is a complete wildcard, but if they actually win, could offer upside of $1 / share.  No immediate time table for this. 

    8)     Brand Equity - Potential Target

    ELY currently trades at 5.4x 2010 EBITDA, 4.4x 2011 EBITDA, with a fully taxed 2010/11 FCF yield of 7%/10%.  Assuming base case scenarios where the company does not even approach the revenue run rate from 2008 until 2012, and normalized trading multiples, we believe the stock could be 50% higher in the next year.  Callaway's brands are premium in the golf industry, which has been hard hit by the recession, but unlike many other consumer stocks, has not seen signficant stock appreciation attributed to the future outlook of the business. 

    2010 guidance calls for growth of 4-10%, with consensus expectations around 6%.  The company has assumed in their guidance that foreign currency will improve compared to 2009 providing 2-2.5% of growth; 4-5% of the increase in 2010 will come from international growth, and the balance will be from a slight recovery in domestic sales.  In addition, they expect a more positive retail environment with less discounting leading to higher gross margins and some increased contribution from uPlay and the new apparel contract.  They have guided for gross margins to improve from 37% in 2009 to 42-44% based on less discounting, forex, manufacturing leverage from higher volume and cost savings associated with gross margin cost savings initiatives.

     


    (I apologize for the table formatting, have been struggling to get it to work) 

    Callaway Capitalization

     

     

     

     

     

     

    Stock Price

     

    $7.94

     

     

     

     

    Common Shares Out

     

    64.5

     

     

     

     

    Diluted Shares Out

     

    19.9

     

     

     

     

    Market Value (if converted)

     

    $669.6

     

     

     

     

    Debt

     

     -

     

     

     

     

    Preferred Stock

     

    140.0

     

     

     

     

    Cash

     

    104.7

     

     

     

     

    Enterprise Value

     

    $564.9

     

     

     

     

     

     

     

     

     

     

     

     

     

    2008

    2009

    2010

    2011

    2012

     

     

     

     

     

     

     

    US

     

    $554.1

    $475.7

    $485.7

    $505.9

    $527.2

    International

     

    $563.0

    $475.7

    $523.5

    $552.9

    $586.8

    Total

     

    $1,117.1

    $951.4

    $1,009.2

    $1,058.8

    $1,114.0

    y/y Growth

     

     

     

     

     

     

    US

     

     

    -14.1%

    2.1%

    4.2%

    4.2%

    International

     

     

    -15.5%

    10.1%

    5.6%

    6.1%

    Total

     

     

    -14.8%

    6.1%

    4.9%

    5.2%

    Gross Profit

     

    $499.4

    $350.0

    $437.2

    $471.5

    $509.8

    Gross Margin

     

    44.7%

    36.8%

    43.3%

    44.5%

    45.8%

    Operating Profit

     

    $96.8

    -$24.4

    $52.6

    $75.9

    $102.1

    % of Revenues

     

    8.7%

    -2.6%

    5.2%

    7.2%

    9.2%

    y/y Growth

     

     

    NA

    NA

    44.3%

    34.6%

    EBITDA

     

    $141.1

    $25.1

    $104.0

    $128.2

    $155.3

    % of Revenues

     

    12.6%

    2.6%

    10.3%

    12.1%

    13.9%

    y/y Growth

     

     

    -82.2%

    314.1%

    23.3%

    21.2%

    Diluted EPS

     

     

    -0.26

    $0.34

    $0.56

    $0.81

    y/y Growth

     

     

     

     

    65.7%

    44.6%

    FCF

     

    $0.00

    -$0.11

    $0.50

    $0.66

    $0.84

    y/y Growth

     

     

     

     

    32.8%

    26.5%

     

     

     

     

     

     

     

    EV / EBITDA

     

    4.0x

    22.5x

    5.4x

    4.4x

    3.6x

    EV / EBIT

     

    5.8x

    -23.2x

    10.7x

    7.4x

    5.5x

    P / E

     

     

     

    23.5x

    14.2x

    9.8x

    P / E (net of cash)

     

     

     

    19.8x

    11.9x

    8.3x

    FCF Yield

     

     

    -1.4%

    6.3%

    8.3%

    10.5%

    FCF Yield (Net of Cash)

     

     

    -1.7%

    7.4%

    9.9%

    12.5%

     

     

     

     

     


    Company Overview

    Callaway has a top-three market share in all major equipment categories - woods, irons, putters and balls.  Over the past few years, Taylor Made has had a strong push into the equipment segment, and taken market share, mostly from other competitors while Callaway has held its own.  They have also been partly responsible for the aggressive discounting in the retail channel, devastating company gross margins during 2009.  During the turmoil of the last year, the market share trend actually reversed, Callaway gained market share in woods (+2%), irons (+1%) and putters (+1%), while losing about 100 bps in share in the ball category.  Callaway, along with its Odyssey brand, are two of the leading names in the industry and the products have typically sold at a premium.  Key competitors in each of the markets are:

     

    Woods

    Irons

    Putters

    Balls

    1)

    TaylorMade (Addidas)

    Callaway

    Odyssey (ELY)

    Titleist

    2)

    Callaway

    TaylorMade

    Ping

    Bridgestone

    3)

    Ping (family owned)

    Ping

    Titleist (FB)

    Callaway/TopFlite

    Golf equipment relies heavily on new product cycles, typically introduced annually.  R&D, has remained a focus of Callaway even during the downturn.  They historically have spent between 3-3.5% of revenues on R&D.  Callaway offers new drivers, typically annually, at various price points between $299 and $499.  This years new offerings include a range of new Odyssey putters, the FT-9, Diablo Edge Tour for woods and Diablo Edge irons.  Odyssey, has over 30% share of the putter market, 10% above its nearest competitor.  Callaway has over 3,000 patents for golf equipment.   

    In 2009, Callaway did not introduce any new balls at the high end, while Titleist did.  During the year, they lost an incremental 1.5% of market share to Titleist (also owns Pinnacle), who has roughly 60% of the market already.  The ball category has been hovering around breakeven, but with cost cuts around ball manufacturing, as well as two new balls introduced at the high end in In January, 2010, (in the the i(z) and i(s) line), they should gain back market share and have positive margins.  From a new product perspective, as well as commentary around the PGA Show held Feb 1 in Orlando, there are positive signs at least in terms of competitive positioning in the market during 2010.   In the latest Golf Digest, Callaway received 10 gold and 5 silver metals for its 2010 lineup, 3 more than its closest competitor.  Callaway had a strong presence at the recent golf show, for both equipment and apparel - with the new Perry Ellis line.  Two big players in the market did not make an appearance at all this year - Nike (b/c of Tiger?) and Taylor Made. 

    Sponsorship

    Callaway has significant brand equity through sponsorship of tour professionals.  Their roster includes Phil Mickelson, Ernie Els, Stuart Appleby, Arnold Palmer, Annika Sorenstam among others.  Payment of these contracts are typically tied to tour success and re-negotiated annually. To the question of Tiger, and his recent woes - the company does not believe that taking Nike's major sponsor away from the game for an extended period of time is a positive competitively for them.  Viewership of PGA tournaments where Tiger does not play have been down in excess of 50%.  So while, they don't expect to be hurt by fewer players, Tiger is an overwhelming positive for the sport, bringing new people into it. Tomorrow, Tiger is apparently going to announce his return to the sport.   

    Revenue Breakdown

    Callaway generates 50% of its revenue from the US market, and 50% internationally.  The international market is growing significantly faster than the US, which is essentially mature.  Over the past few decades, the golf industry in the US grew rapidly, building excess supply of courses and equipment sales peaking between 2005-2007.  Despite significantly lower spending, golfers continued to play through the recession.  In previous recessionary periods, golf sales have troughed around the same time that the recession ended. In 2009, rounds of golf played in the US were flat at 488 million (they have essentially been at this level since 2000), and the National Golf Federation projects another year of flat rounds, despite fewer courses in 2010.  2009 had a record number of closures at 140, compared to 32 in the 2001 last recession.  Core golfers in the US (defined as >8 rounds / year) were 16.6 million, with 12.7 million occasional golfers. 

    International revenue is derived from over 110 countries.  Japan makes up 17% of revenues, other Asia including Korea makes up 8%, Europe at 14% and the Rest of World at 11%.  While the Japanese market is fundamentally mature with 9% of the population playing golf  - similar to the US 10%  penetration) Callaway continues to grow in those markets through new product introductions and market share growth. 

     

    FY Ended  December 31, 2008 2009 1Q10E 2Q10E 3Q10E 4Q10E 2010 2011 2012
    Revenue by Region
       



         
    US
    $554.1 $475.7            144.7         165.4           96.6           79.0 $485.7 $505.9 $527.2
    Europe
               190.9            134.6              47.8           45.1           26.6           21.0        140.5        146.5        153.4
    Japan 
               166.6            162.8              52.9           43.3           31.6           50.5        178.4        187.8        196.8
    Rest of Asia
                79.9             77.0              20.6           23.3           23.0           19.6         86.6         92.6        100.2
    Other
               125.6            101.4              31.6           43.4           21.9           21.1        118.0        126.1        136.5
    Total
    $1,117.3 $950.9 $297.7 $320.5 $199.7 $191.3 $1,009.2 $1,058.8 $1,114.0


       



         
    Country Breakdown
       



         
    US
    49.6% 50.0% 48.6% 51.6% 48.3% 41.3% 48.1% 47.8% 47.3%
    Europe
    17.1% 14.2% 16.1% 14.1% 13.3% 11.0% 13.9% 13.8% 13.8%
    Japan 
    14.9% 17.1% 17.8% 13.5% 15.8% 26.4% 17.7% 17.7% 17.7%
    Rest of Asia
    7.2% 8.1% 6.9% 7.3% 11.5% 10.2% 8.6% 8.7% 9.0%
    Other
    11.2% 10.7% 10.6% 13.5% 11.0% 11.1% 11.7% 11.9% 12.3%
    Total
    100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


       



         
    Growth by Region
       



         
    US
    -7.3% -14.1% 2.4% 1.0% 2.8% 3.1% 2.1% 4.2% 4.2%
    Europe
    -1.2% -29.5% 11.3% 5.8% -1.9% -4.2% 4.4% 4.3% 4.7%
    Japan 
    38.8% -2.3% 11.9% 16.5% 8.3% 2.9% 9.6% 5.2% 4.8%
    Rest of Asia
    -6.8% -3.7% 24.4% 10.3% 9.7% 7.6% 12.5% 6.9% 8.2%
    Other
    -1.6% -19.3% 33.4% 14.8% 10.3% 5.3% 16.4% 6.9% 8.2%
    Total
    -0.6% -14.9% 9.5% 6.1% 4.6% 2.9% 6.1% 4.9% 5.2%


       



         
    Product % of Sales
       



         
    Woods
    24.0% 23.5% 29.6% 24.9% 18.4% 17.3% 23.6% 23.4% 23.3%
    Irons
    27.6% 24.6% 24.2% 24.1% 26.2% 25.6% 24.8% 24.8% 24.8%
    Putters
    9.1% 10.3% 10.1% 8.8% 9.1% 13.7% 10.2% 10.2% 10.2%
    Golf Balls
    20.0% 19.0% 17.2% 19.2% 21.3% 18.9% 19.0% 18.7% 18.5%
    Other
    19.3% 22.5% 18.9% 23.1% 25.0% 24.4% 22.5% 22.9% 23.3%
    Total
    100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
                         

    Golf sales are highly seasonal, with 1H providing between 60-65% of revenues and the majority of profits.   Distribution of products varies by market, however domestically, sales are distributed broadly through golf specialty (35%), Green Grass (30%), Sporting Goods (20%), Mass merchants (10%) and Corporate (5%). 

     

    1)  Cyclical recovery

    Economic indicators in the US, making up 50% of revenues, have improved significantly on a y/y basis.  Q1 2009, consumers remained in a state of panic, with consumer sentiment indexes hitting all time lows.   The U. of Michigan Consumer Sentiment Index had a January reading of 61.2, Feb of 56.3 and March of 57.3, while January 2010 had a reading of 74.4, a 21% improvement.  The Conference Board Consumer Confidence Index saw lows of between 25 and 37 in Q1 2009 vs January 2010 reading of 55.90.  Clearly there are still serious issues in the US economy, but given the recent strength of retail sales, consumer confidence and other leading indicators, one can surmise that in Q1 2010, the consumer is in better shape than the beginning of 2009.  While leading indicators have been tracking in the right direction for 9 months, unemployment remains stubbornly high at 10%, while in Q1 2008, it was around 8%.  With 1H making up over 65% of revenues historically, the company should see a benefit of easier comps in 1H 2010.  However, from a product standpoint, the company has been seeing consumers purchasing down to lower price points; ie: instead of purchasing the new $399 driver, they are getting the $299 driver.  I do not expect this behavior to change in the near term.  Similar to what we have seen in retail sales - including flat screen TVs, other electronics and other sporting goods, there is pent-up demand for discretionary products that consumers have not purchased in almost two years.  

    During the Q1 call on January 26, management had cautious optimism about the economic recovery as it relates to their business.  Pre-books of new products in January have been in-line with expectations, while orders for immediate delivery have been heavier than in 2009, reflecting retail conservatism around inventory build.  The Sun Belt so far has show early signs of improvement, despite varied weather.  Retailers have lean inventory levels, after a year of reducing the amount of inventory purchased.  This may represent an opportunity later in the year, as retailers become more confident in the pace of the recession and build inventories - but at worst it should be neutral this year.  No inventory refresh has been baked into the company's guidance. 

    International revenues have been in a cyclical upswing since Q4, where they grew 21% on a currency neutral basis in Q4, with US revenues down 14%.  Several long-term drivers will allow the company to continue to post robust international revenue growth for the next few years.  It is important to note that Callaway actually derives higher gross margins from its international operations - typically selling more expensive and higher end items abroad.  They target the higher end consumer, not the mass market and tend to see less promotional discounting. 

    Discounting of leading brands at retail in an effort to spur demand in 2009 had a significant impact on gross margins which for the full year came in at 36.8%, down from 44.7% in 2008.  TaylorMade was one of the larger aggressors of discounting.  In many cases, discounts were - buy a driver, get one free fairway woods - offering $150 to $200 of value to the consumer.  As smaller, more marginal brands lost shelf space to the major brands in 2009, Callaway was able to gain market share as mentioned before.   Comments from the Q1 call also point to a more rational pricing environment, while obviously still early in the year.  In addition, Callaway inventory levels at 12/31 were $219 mm, down from $257 mm a year ago, and the lowest level in 5 years.

    Callaway had a strong product lineup in the market in 2009, and it seems that they again will show technological strength in 2010 (read comments above about lineup).  This will provide somewhat of a tailwind if the industry stabilizes and begins to show growth in 2010.  Lastly, Dicks Sporting Goods results indicated that consumers are beginning to come back to retail to purchase sports equipment. 

     

    2) Cost Savings - Gross Margin Expansion

    Aside from gross margin expansion coming from firming of the promotional market, the company has cut costs aggressively over the past 3 years, in an effort to make the company and supply chain more efficient.  From 2007-2009, the company cut $70 million out of its fixed costs, and have identified another $25-$45 to eliminate from 2010 - 2012, with about 1/3 of that coming in 2010.  Much of the additional cost savings is both from outsourcing manufacturing and moving some of it offshore.  Currently, they manufacture around ½ of the products internally.  Other areas of cost cutting include logistics, warehousing, international operations and distribution.  Due to these initiatives, lead-times historically have been in the 145 to 175 range, and now are down to 45 days. Given their track record in the past 3 years of cost cutting on schedule, I am giving them credit for the low end of their cost cuts in my projections. This should obviously drive increased operating leverage as revenues ramp.  

     

    3) Foreign Exchange

    The company was hard hit by currency exchange in 2009.  Specifically, the USD strength against the Euro, GBP, and secondarily the CAD, AUD and Korean Won provided a significant headwind in 1H 2009 where  revenues were impacted negatively by $42 million - about 7% of 1H revenues.   Assuming current currency levels through 1H, the company would gain back about ½ of what they lost in 1H 2009 or about $21 million.  Typically, a $1 move in revenues due to currency, will impact operating margin by $0.65.  Currency effectively hurt 1H 2009 operating income by 25%, and can be a tailwind in 1H 2010 by about 14%.  The back half of 2009 was less impacted by currency, and actually saw a slight benefit.  I am modeling for a flat currency environment in 2H 2010 and going forward.  The company typically does not hedge its FX risk.   I am assuming a USD/Euro of 1.37, USD/GBP of 1.58 and Yen/USD of 90. 

     

    4) Foreign Growth Opportunity

    The international growth opportunity is the secular long term growth story for Callaway.  As mentioned previously, international revenues represent about 50% of total revenues.  European revenue makes up 14%, Japan 17%, Rest of Asia including Korea is 8% and 'Other' including Australia, South Africa, Canada, Latin America make up the remaining 11%.  Over the next three, years, management believes it can comprise 60% of revenues.  Using my conservative projections, after three years, I have international revenues at 52% of revenues, and int'l growing at a 3 year CAGR of 7%.  If management's aggressive comments (which I take with a grain of salt) are correct, assuming no growth in US revenue (which is unrealistic), International would be growing at a 3 year CAGR of 15.5%.  Total 2012 international revenues would be $733 bn vs. my estimate of $578 billion.  This is simply illustrative to show the potential for international growth vs. the conservative estimates in my base case. 

    In October the International Olympic Committee selected golf to be included in the 2016 summer Olympics.  This could potentially create a large tailwind through 2016 for international government and private spending around teaching and training golf, as well as buidling new golf courses.  This is especially true for those countries like India and China where the Olympics represent an important public forum to represent their nation.  China has already hired the Australian PGA to train Chinese pros in order to bring them up to worldwide caliber.  In addition, well known athletes have indicated they will play in the Olympics, driving more awareness and interest in the sport.  The world's 15 top layers would automatically qualify regardless of the number of players from a given country, and then a maximum of two players from each country would be allowed to compete.   If you simply think about the 4.7 billion people that watch the Olympics vs the few million that watch the PGA, clearly a much larger demographic will be exposed to the sport, including a younger group than the avg golfer. 

    It is estimated that there are currently between 2-3 million golfers in China, and the sport is growing at 50% per year.  3.7 mm golfers are expected by y/e 2010, and 500-1000 new golf courses are expected to be added over the next few years to the roughly 500 that exist now. 

    The company will be introducing the Callaway brand to India on February 15th, with products beginning to hit the shelves in mid March.  Currently, there are about 500,000 golfers in India, with 250 golf courses in operation and 50 more being built.  Management ran through a scenario during the recent call framing the market opportunity for India.  If 2% of the population play golf (vs 10% in the US), and spend 1/3 of the average US spend ($123/yr), then the market would be $1.2 billion.  The professional Indian domestic golf market is beginning to take shape as well, with prize money growing from around $700k a few years back to close to $2 million in 2010.  Top international golfers have recently been playing in foreign sponsored tournaments in India, attracted by increasing sponsorship money.  In addition, big names like Greg Norman, Nick Faldo, Gary Player and Jack Nicklaus have contracted with developers to design signature golf course in India.   India actually has a long history of golf, through its British heritage - the second-oldest golf course in the world is actually located in Calcutta and was built in 1829.  Currently, resort and property developers are looking at golf as a new lure for international tourism leading to a course building boom.  Callaway is teaming up with the #1 domestic Indian golfer - Jeev Mikah Singh as its brand ambassador to help get the sales effort off the ground.  Industry analysts believe the Indian golf market has been growing 25-30% a year for the past three years, and is now hitting a growth inflection point.  Callaway plans to market from multi-brand outlets beginning March 1, and roll out to exclusive stores in 2H 2010.  As noted above, Callaway typically derives higher margins from international operations and India should perform in a similar manner.  They are planning on selling FT1Z driver for north of $500, and sets of clubs ranging from $200 to several thousand $s. 

    The Japanese market is somewhat unique.  Penetration of golfers is 9%, vs 10% in the United States, but Callaway is still growing very rapidly there, primarily from market share gains.  In 2008 on a constant currency basis, Japanese revenues were up 22%, and down 12% in 2009.  I am modeling for a tepid recovery over the next few years of 5-6% growth. 

    In Latin America, Callaway currently sells into Mexico, however not into most countries in South America.  The 2016 Olympics will be held in Brazil, and currently Callaway does not sell product there.  This could be a large potential market for the company in the future. 

    Europe has been a slower growth market than Asia.  Ireland and UK represent a large piece of the 14% of revenue represented by Europe, but not most of the growth.  Revenue was down 4% on a constant currency basis in 2008 and down 18% in 2009.  I am not modeling significant growth for the European markets, although given the low penetration rates in most countries, the potential exists.  Western Europe is a mixed bag of interest in golf.  Penetration in certain countries such as France and Germany remains low, while Ireland, UK, Denmark and Scandinavian countries have a more mature market.  Eastern Europe has seen the number of golf courses triple to 135 in the last decade, and the sport is just beginning to evolve there.  

    5) Perry Ellis Contract

    Callaway through 2009 had a apparel deal with Ashworth, where it was a pure royalty arrangement and Callaway had very little control of the product or distribution.  This contracted ended in 2009, and they signed a new contract with Perry Ellis.  2009 was a transition year as they ramped down Ashworth and began production and development with Perry Ellis.  2010 will present the first full year of Callaway branded Perry Ellis apparel.  The full P/L will flow through Callaway's income statement now, showing a lower margin than the previous contract which was strictly royalties, but larger potential for margin dollars.  The pure margin falling off in 2009 also added to the decline in gross margins.  The company has discussed that a good data point to size the opportunity is TaylorMade's apparel business, which is roughly $200 million in apparel and $100 mm in footwear annually.  Currently, Callaway does little in both of these categories, but has the potential to leverage its brand equity and distribution channels.  This deal will allow Callaway to be more involved, including selling to the golf clubs and other distribution channels that it has relationships with - which was not the case under the Ashworth contract. 

    uPlay is a Golf GPS device product, that Callaway purchased on December 31, 2008 for roughly $10 mm.  They offer two products uPlay for $399 and Go for $299; both offer course libraries, GPS ball positioning, aerial topography of the course etc.  The higher end model offers additional features like green contours and more aerial details.  They have seen good traction, especially through the holiday gift giving period.  However, I remain skeptical of the long tem growth opportunity in this business given the advent of smartphone software that essentially has most of the functionality of uPlay.  Like the PND market though, there is a niche market for avid golfers who prefer the dedicated device for golf, and easier user interface.  I have not baked in significant revenues from uPlay going forward. 

    6)  Dividend Reinstatement

    The company cut its dividend concurrent with the Preferred offering in an effort to save cash.  At the time, the dividend was $0.28 / year - or a 6% yield last June.  The dividend was cut to a nominal $0.04 / year.   The company has commented that at the right time, they would likely reinstate a higher dividend - and I think by not completely eliminating the dividend they have in effect stated their commitment to having one.   This is likely more of a 2011 event. 

    7)  Golf ball patent lawsuit resolution

    A favorable outcome with Acushnet regarding the patent lawsuit over the Titleist Pro VI would be a boost to the stock, and could create a windfall of up to $70 million.  The case will be heard by the district court again in March 2010.  Obviously there is no way to handicap the outcome.  

    8)  Brand Equity & Potential Target

    Callaway's brand is one of the golf industry's premier names, in the company of Titleist, Taylormade, Nike and Ping.  There is clear value to a larger conglomerate (Addidas, Nike?) to owning the Callaway brand, market share and history of R&D expertise, among other things.  While this is not core to the thesis, given the relative valuation, market cap and value that Callaway brings, I would not be surprised to see them as a takeout candidate down the road.

    Valuation

    Based upon these scenarios, my bull/base/bear case are as follows.  All valuation metrics are shown on an 'if converted basis' to take into consideration dilution from preferred offering.  

    The company currently trades at 5.4x 2010 EBITDA in my base case scenario, with a fully taxed 7.4% FCF yield.  Looking out to 2011 it is trading at 4.4x EBITDA, 12x EPS with a 10% FCF yield.  I have backed out cash from the analysis given the almost nil yield they are getting on it. 

     

    Bull

     

    Base

     

    Bear

    Revenues

    2010

    2011

     

    2010

    2011

     

    2010

    2011

    US

    $641.6

    $684.4

     

    $485.7

    $505.9

     

    $618.6

    $638.3

    International

          395.7

         436.1

     

         523.5

         552.9

     

          376.6

          393.0

    Total

    $1,037.3

    $1,120.4

     

    $1,009.2

    $1,058.8

     

    $995.2

    $1,031.3

    y/y Growth

     

     

     

     

     

     

     

     

    US

    34.9%

    6.7%

     

    2.1%

    4.2%

     

    30.0%

    3.2%

    International

    -16.8%

    10.2%

     

    10.1%

    5.6%

     

    -20.8%

    4.3%

    Total

    9.0%

    8.0%

     

    6.1%

    4.9%

     

    4.6%

    3.6%

     

     

     

     

     

     

     

     

     

    Gross Profit

    $454.4

    $509.0

     

    $437.2

    $471.5

     

    $428.6

    $454.7

    Gross Margin

    43.8%

    45.4%

     

    43.3%

    44.5%

     

    43.1%

    44.1%

     

     

     

     

     

     

     

     

     

    Operating Profit

    $61.3

    $95.2

     

    $52.6

    $75.9

     

    $48.2

    $67.2

    % of Revenues

    5.9%

    8.5%

     

    5.1%

    7.2%

     

    4.6%

    6.5%

    y/y Growth

    NA

    55.1%

     

    NA

    44.3%

     

    NA

    39.6%

     

     

     

     

     

     

     

     

     

    EBITDA

    $112.8

    $147.5

     

    $104.0

    $128.2

     

    $99.6

    $119.5

    % of Revenues

    10.9%

    13.2%

     

    10.3%

    12.1%

     

    10.0%

    11.6%

    y/y Growth

    349.1%

    30.8%

     

    314.1%

    23.3%

     

    296.6%

    20.1%

     

     

     

     

     

     

     

     

     

    Diluted EPS

    $0.42

    $0.75

     

    $0.34

    $0.56

     

    $0.30

    $0.48

    y/y Growth

     

    76.4%

     

     

    65.7%

     

     

    61.3%

     

     

     

     

     

     

     

     

     

    FCF

    $0.56

    $0.77

     

    $0.50

    $0.66

     

    $0.47

    $0.61

    y/y Growth

     

    39.0%

     

     

    32.8%

     

     

    31.6%

     

     

     

     

     

     

     

     

     

    EV / EBITDA

    5.0x

    3.8x

     

    5.4x

    4.4x

     

    5.7x

    4.7x

    EV / EBIT

    9.2x

    5.9x

     

    10.7x

    7.4x

     

    11.7x

    8.4x

    P / E

    18.8x

    10.7x

     

    23.5x

    14.2x

     

    26.8x

    16.6x

    P / E (net of cash)

    15.9x

    9.0x

     

    19.8x

    11.9x

     

    22.6x

    14.0x

    FCF Yield

    7.0%

    9.7%

     

    6.3%

    8.3%

     

    5.9%

    7.7%

    FCF Yield (Net of Cash)

    8.3%

    11.5%

     

    7.4%

    9.9%

     

    6.9%

    9.1%

    Pure competitors are hard to find in this space - so I have looked at companies with strong brands, and are present in the sports equipment or apparel industry.  I think the appropriate way to view the numbers is on 2011 or 2012 ( I have used 2011), based on the time it takes for the cyclical recovery to take shape.  Assuming my base case numbers, and applying competitor multiples, the stock should be trading 60% higher than it currently is on an EV/EBITDA basis.   Applying a 2012 EPS estimate of $0.75, showing the earnings potential of the company to a average multiple of 15x, gets me north of $11 / share, or about 40% higher than the current price.  This story will take some time to unfold, but given the above mentioned catalysts, the trough valuation and positive secular and cyclical story ahead, patient investors can find a good entry point in the name. 

    In the downside scenario, the share price is backstopped both by its current valuation, and by book value / share.  Assuming the bear case scenario and a 2011 EPS comp multiple, the stock could dip to the $7 level, or about 15% below current prices.  Additionally, downside is backstopped by a book value / Share of over $ 8 / share.  If you back out intangibles/goodwill and assume full conversion of preferred stock, you get to $6 / share - 25% lower. 

    Competitive Universe

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    EV / EBITDA

     

    P/E

     

     

     

     

    Price

     

    Market Cap

     

    Ent Value

     

    2010

    2011

     

    2010

    2011

     

    Div Yield

    Adidas

     

    € 36.75

     

    € 7,688.7

     

    € 10,035.7

     

    12.7x

    9.0x

     

    28.1x

    15.4x

     

    na

    Brunswick Corp.

     

    $12.28

     

    $1,084.3

     

    $1,408.6

     

    59.6x

    6.3x

     

    NA

    NA

     

    0.79%

    Columbia Sportsware

     

    $44.70

     

    $1,510.7

     

    $1,101.3

     

    8.5x

    7.9x

     

    21.3x

    18.6x

     

    1.69%

    Fortune Brands

     

    $42.79

     

    $6,433.2

     

    $10,493.9

     

    9.8x

    8.9x

     

    15.8x

    12.9x

     

    2.34%

    Life Time Fitness, Inc.

     

    $26.60

     

    $1,100.8

     

    $1,776.0

     

    6.8x

    5.9x

     

    13.8x

    12.5x

     

    0.00%

    Mizuno

     

    ¥408.00

     

    ¥54,219.6

     

    ¥58,489.6

     

    10.9x

    9.6x

     

    26.4x

    21.6x

     

    1.86%

    Nike

     

    $64.37

     

    $31,719.1

     

    $28,279.7

     

    10.2x

    9.2x

     

    17.5x

    15.6x

     

    1.57%

    Polaris Industries, Inc.

     

    $44.08

     

    $1,441.4

     

    $1,501.2

     

    6.3x

    5.7x

     

    13.4x

    12.3x

     

    3.58%

    Smith & Wesson Corp.

     

    $4.25

     

    $253.9

     

    $293.6

     

    5.4x

    5.0x

     

    11.4x

    10.5x

     

    0.00%

    Timberland

     

    $18.06

     

    $999.6

     

    $709.7

     

    5.9x

    NA

     

    17.1x

    15.5x

     

    0.00%

    Under Armor

     

    $25.68

     

    $1,288.3

     

    $1,121.2

     

    9.2x

    8.0x

     

    24.4x

    21.4x

     

    0.00%

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Min

     

    5.4x

    5.0x

     

    11.4x

    10.5x

     

     

     

     

     

     

     

     

    Mean

     

    13.2x

    7.5x

     

    18.9x

    15.6x

     

     

     

     

     

     

     

     

    Median

     

    9.2x

    7.9x

     

    17.3x

    15.5x

     

     

     

     

     

     

     

     

    Max

     

    59.6x

    9.6x

     

    28.1x

    21.6x

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    ELY - Bull

     

    $7.94

     

    $669.6

     

    $564.9

     

    5.0x

    3.8x

     

    18.8x

    10.7x

     

    0.50%

    ELY - Base

     

    $7.94

     

    $669.6

     

    $564.9

     

    5.4x

    4.4x

     

    23.5x

    14.2x

     

    0.50%

    ELY - Bear

     

    $7.94

     

    $669.6

     

    $564.9

     

    5.7x

    4.7x

     

    26.8x

    16.6x

     

    0.50%

     

    Valuation at Median Comp Multiples

     

     

     

     

    EV / EBITDA

     

    P/E

     

     

     

     

     

     

     

     

    2010

    2011

     

    2010

    2011

     

     

     

     

     

     

     

     

    9.2x

    7.9x

     

    17.3x

    15.5x

     

     

     

     

     

     

     

     

     

     

     

     

     

    ELY - Bull

     

     

     

     

     

     

     

    $13.48

    $17.59

     

    $7.30

    $11.54

    ELY - Base

     

     

     

     

     

     

     

    $12.52

    $13.29

     

    $5.85

    $8.69

    ELY - Bear

     

     

     

     

     

     

     

    $12.05

    $14.53

     

    $5.13

    $7.41

     

     

     

     

     

     

     

     

     

     

     

     

     

    % Upside / Downside

     

     

     

     

     

     

     

     

     

     

     

     

    ELY - Bull

     

     

     

     

     

     

     

    69.7%

    121.6%

     

    -8.1%

    45.4%

    ELY - Base

     

     

     

     

     

     

     

    57.7%

    67.4%

     

    -26.3%

    9.4%

    ELY - Bear

     

     

     

     

     

     

     

    51.7%

    83.0%

     

    -35.4%

    -6.7%

     

    Risks

    Of course I could be wrong in my analysis and outlook for the golf industry.  Below are a few points which could lead the thesis in the wrong direction. 

    One of the key industry problems that plagued the company in 2009 was competitive discounting.  If consumer demand remained weak, competitors could resort again to price discounting to drive store traffic, thus driving down gross margins.  This is a real risk, one they have not seen yet in early 2010, but if the sales season does not come together as expected, the industry may resort to this.  This would cap any upside in the name, lead to lower gross margins and slower revenue growth. 

    Secondly, and more obviously, a double dip recession or much slower pace of economic recovery could put a limit on the amount consumers are willing to purchase for sports equipment. 

    There is a belief that consumers have permanently changed the way the purchase consumer discretionary items now, always looking for discounts.  While this may be the case in the next year or two, I don't believe there is a permanent  change, and do think that consumer will return to buying premium products.  However, if I am wrong, and consumers permanently change their purchasing behavior, and continue to purchase lower end products, revenue growth will be constricted and it will be harder to return to the 45+% gross margin levels. 

    There is always the possibility of a destruction of brand image, either through poor R&D and product development, or from moral issues from the individuals they are sponsoring (ala Tiger).  This is unquantifiable. 

    If the US $ strengthens through the year, leading to more difficult foreign currency translation, the company would continue to suffer, and revenue growth would be hampered. 

     

    Catalyst

    1)     Cyclical recovery - pent up demand for drivers, irons, putters and attire from avid golfers should begin to grow off depressed 2009 levels

    2)     Cost savings initiatives will remove $25-$45 million in the next 3 years; allowing the potential of peak gross margins approaching 50% in several years time 

    3)     Foreign exchange tailwind through 1H 2010, where 65% of annual sales are expected

    4)     Secular Foreign growth opportunity in China, India, Latin America, Japan, Korea and other parts of SE Asia. 

    5)     New products such as uPro (golf course GPS device) and a renewed apparel strategy with Perry Ellis take shape

    6)     Dividend reinstatement 

    7)     Patent lawsuit with Titleist resolution

    8)     Brand Equity - Potential Target

    Messages


    SubjectQuarter
    Entry06/20/2010 11:09 AM
    Memberhbomb5

    jdr:

    Thanks for the writeup.  What are your thoughts on ELY's quarter and do you think it is a better value at current quote.  

    Thanks

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