COMMENTARY | COLUMNISTS | BRENT WILSEY

Callaway Golf Co. performance under par for investors

I have heard many people say “Invest in what you know and what you love.” While I think that may be a good place to start, it may not be the best overall investment strategy.

There are many people who love golf. However, the growth in the game appears to be declining.

Last week, I learned that Dick’s Sporting Goods announced it was laying off more than 400 PGA golf professionals. The CEO of the company, Ed Stack, went as far as to say the majority of the company’s earnings shortfall was a decline in golf sales.

I took a deeper look at the situation and discovered that young people – millennials -- have no interest in playing golf at all. The National Golf Foundation was quoted by Bloomberg that as many as 200,000 players age 35 and younger have simply abandoned the game. The foundation went on to say that people would rather watch Tiger Woods than try to play like Tiger Woods. This led me to look at golf companies to see if they are seeing declining sales and earnings and declines on the projected earnings.

I took a look at San Diego-based Callaway Golf Co. (NYSE: ELY), which currently trades about $8.50 per share. The stock has a 52-week high of $10.35 and a 52-week low of $6.76. The market cap stands at $661 million. The company designs, manufactures and sells golf clubs and balls along with accessories including bags and headwear.

I always like to look at the valuation ratios first just to see what I’m paying for the earnings, sales, book value and cash flow. It was not a good start for Callaway -- the current price-earnings ratio for the last 12 months is not material, which tells me the company has had no earnings over the last 12 months.

Price to sales, however, does look good for the company at 0.74 -- well below the industry average of 1.24. Price to tangible book value also looks good at 3.0 -- not quite one-third the industry average of 8.27. Price to cash flow for the company does not look good at 41 times, not quite twice the industry average of 21.7. Keep in mind valuation ratios: the lower the number the better.

Investors won’t get very excited about the dividend yield at 0.46 percent, which is about the same yield they receive in the bank on a one-year CD with no risk. Over the last 12 months, year-over-year sales increased at 8.4 percent -- far below the industry average of 28.1.

Callaway Golf competes in the sporting and outdoor goods industry, which overall appears to be doing better than the golf industry. Earnings per share for the last 12 months year over year were up 84 percent for the company, beating the industry growth of 59.8 percent.

I was curious how the company could grow earnings per share at 84 percent on 8 percent sales growth. What I discovered was in the quarters ending September 2012 and December 2012, the combined loss per share was $2.34. This caused the base number to be low, therefore appearing to show a large growth in earnings per share when in reality, the earnings growth was based off of a low four-quarter time frame.

Callaway’s balance sheet looks respectable, with a current ratio of 1.8, slightly under the industry average of 2.0. The debt to equity is 31.6 for the company, which is higher than the industry average of 25.5; however, I would not be concerned with a debt to equity of 32 percent.

If there is a slowdown in golf sales, the current debt of $800 million -- which all is long-term debt -- would not cause excessive strain on the company’s financial situation. The return on equity does not look good for the company at a negative 2.3 percent when compared with the industry average of a positive 21.5 percent.

For every dollar the company brought in over the last 12 months, it lost about a penny -- or a negative net profit margin of 0.58 when the industry was a positive 5.46.

Looking at the efficiency of the company, there could be a problem with the receivable and inventory turnover. The receivable turnover for Callaway over the last 12 months is 3.33, far below the industry average of 15.2. Inventory turnover for the last 12 months was 2.49 for the company -- less than half the industry average of 6.49

Looking forward out to December 2015, the mean of eight analysts is looking for earnings per share of 43 cents. While this looks good -- doubling the December 2014 earnings per share of 20 cents -- I would point out that using a multiple of 20 times forward earnings would yield a stock price of $8.60 right at current levels.

And for me, a forward multiple over 16.5 is in the sell category, not the buy category.

A good indicator of what investors are paying for the future growth of a company is the price earnings divided by the growth, also known as a PEG ratio. The industry has a peg ratio of 1.62; compare that to the expensive company peg ratio of 8.83.

So while the shares of this golf company may go higher, the risk of investing in this company would be high based on warning signs of a slowdown in participants in the sport along with the current high forward multiples of earnings per share.

Have a question or a company you'd like me to take a look at? Email me at brent@wilseyassetmanagement.com.



Wilsey is president of Wilsey Asset Management and can be heard at 8 a.m. every Saturday on KFMB AM760. Information is provided by Reuters.

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