Sunday, November 10, 2013

Callaway Golf Co ELY

Callaway Golf Co ELY

Summer is a time of year in which many individuals cut back in their work schedules and seek leisure, vacation, and time with their families. One of the predominant activities that affluent and educated people pursue in their free time is golf. A recent study about golfers provides an interesting vista into the lives of those who pursue this sport for recreation.

The average golfer has an annual household income of over $80,000Over 50%of golfers have some college experienceOver 90% of golfers own their homeOver 50% are Baby BoomersThese demographics allow an analyst to pinpoint the characteristics that describe a typical golfer as well as provide information that can lead to a strategic investment. Before being able to name that investment, we must first do a little more research about the golf industry.

Within the United States, there is currently a decrease in interest in the sport of golf. This decrease can be measured in several ways, one if which is the demand for access to housing near golf courses. The logic of this relationship is that some individuals who are passionate about golf will attempt to live near golf courses so that they can frequently and easily enjoy their sport. This statement certainly doesn't apply to every individual, but in a population of golfers, it stands to reason that at least a small percentage would attempt to be as close as possible to their hobby. A recent article in the Wall Street Journal paints a very interesting story about this relationship. It notes that at one time, there was a strong demand for housing near golf courses, but a decrease in popularity of the sport has led to a decrease in demand for nearby housing. This article gives a description of the industry and points to the fact that it is both overbuilt and experiencing a decrease in interest.

A very simple experiment can be conducted to determine if, in part, the decrease in golf is true. A powerful way of gauging public interest in a particular topic is to examine what people search for on the internet. The reasoning is that if people are interested or passionate about a topic, they will frequently search for news, advice, or information about their chosen field. Below is a chart of a simple Google Trends search for "golf." I have added a simple line connecting the peak demand for the product to reveal the current trend.

Several interesting conclusions can be drawn from this data, but the primary two are that golf demand peaks during the summer and the public demand for information on golf is decreasing. With such a clearlypainted picture, a contrarianminded individual would be wise to look for ways of investing in this situation. If there are companies which profit from the golf industry, they are nearing the height of their seasonal demand. It stands to reason that their profits are at a seasonal peak and their stock price should eventually price this in.

A company that I believe is particularly prone to a continued downturn in the golf industry is Callaway Golf Company (ELY). Callaway is one of the premier names within the golf paraphernalia industry and according to its annual filing, "The Company generates substantially all of its revenues from the sale of golfrelated products" (page 23). In other words, the majority of the company's revenue comes from an industry which is in decline. The annual filing substantiates this by further saying "if golf participation or the number of rounds of golf played decreases, sales of the Company's products may be adversely affected" (page 23). These statements are found in a portion of the filing known as Risk Factors. Essentially this is where the company tells investors what the worstcase scenarios could potentially be. It is my claim that even though the company has a strong name and a lasting brand presence, this will not be enough to sustain the current stock price. I believe that Callaway Golf Company will suffer over the coming years as the decline in golfing interest continues. This said, I do not believe that this type of short opportunity is found by looking strictly at the balance sheet but rather by examining the entire industry. I believe that Callaway Golf Company at the current summer price levels provides an excellent longterm shorting opportunity.

The reason that I believe Callaway will perform poorly rather than its primary peers is that it already "has a significant share of worldwide sales." Given its current position as the seller of premium golfing items and the fact that its primary demographic has been hit particularly hard by the recent financial crisis, I do not see it being able to continue to grow in the face of a downturn. Callaway already recognizes that it is losing position in its risk disclosure by stating that sales are at risk of not growing or even declining in the future. In the event of a global downturn in demand for golfing, Callaway is not in a position to grow market share. It is my argument that this global downturn is currently occurring and Callaway has already exhausted its competitive expansion. Since it has already achieved market strength, it does not have expansion room and industry demand directly affects sales going forward, as it has noted. This said, Callaway represents a strong leader in the declining golf industry. Its position denotes a good opportunity to sell into the weakness of golf as a sport.

In the markets, I prefer to think fundamentally and execute technically. This said, I believe that the most logical time to enter the market is when market price action actually agrees with your fundamental analysis. I believe that the chart seen below shows a chart experiencing breakdown in which a downtrend is starting. The bulls have defended the $5.20 per share point for the past quarter and I believe that if prices were to fall through this barrier, we could see the continued decline in share price.

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