Callaway Golf: Lowering Estimates for 2008

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

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1. Lowering 2008 Revenue and EPS Estimates

We are lowering our estimates for both revenues and EPS for 2008. 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. We discussed this on our Bloomberg Business Radio interview on Memorial Day. The degree to which corn planting over a 22 state geography had fallen behind made it clear to us that weather was a significant issue, and that therefore rounds played were almost certainly down for the spring months in those geographies. If you can’t plant corn, you aren’t playing golf. If you are stacking sand bags, you aren’t playing golf.

We are lowering Q2 revenues by $10 million and shaving our EPS estimate from $0.70 per share to $0.65 per share. We are taking Q3 revenues down from $230 million to $220 million and EPS from $0.03 per share to $0.02 per share. For Q4 we are lowering revenues from $150 million to $140 million and increasing the loss per share from ($0.23) per share to ($0.24) per share. This takes our full year EPS estimate down from $1.08 per share to $1.01 per share, matching the current low estimate on the Street.

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. Still, this may set the stage for what is likely to follow.

2. No change for 2009 Revenue or EPS Estimates

This is where we break ranks with the rest of the analytic community. As they rush to take down their 2009 numbers, we are going to leave ours alone. Why? Because we 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. Having the new club introductions set up for 2009, when the pent up demand should become evident, will allow Callaway to take full advantage of the incremental demand. Our sense is this could be key to an upside surprise next year.

3. The Tiger Factor

When Tiger Woods went on the disabled list after the US Open, we were immediately deluged with questions from the media as to the impact of his absence on the game. We would answer that ‘It depends upon who you are.’ If you are a television outlet dependent upon viewers for your income, then the absence of Tiger clearly hurts. But we could see a scenario where actual golfers will not be so inextricably tied to their TV sets on Saturday and Sunday afternoons, and that play rates could actually tick up slightly due to the absence of Tiger.

Secondly, if the absence of Tiger is as bad for the game as the share prices of golf companies made it seem, well remember that he is coming back next spring, and it should create a great deal of excitement. But it is not like 9 million core golfers in the US all quit the game, as the markets would have you believe.

4. Micromanaging the Recommendation

So clearly we are more constructive on 2009 than most. With the stock in the $11’s, an 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 work on the cyclicality of the shares suggests we should wait a little longer.

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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.

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.