Looking Risky to Tee Up Here

 | Nov 06, 2012 | 9:30 AM EST
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Callaway Golf (ELY) closed up 6% Monday, less than one week after the company's new CEO, Oliver Brewer, bought 20,000 shares of the stock at an average price of $5.50. Brewer, before taking the job in March, had previously served as president and CEO of Adams Golf. Another insider, Mark Leposky, bought shares in August at an average price of $5.75, according to our database of insider filings. Insider purchases tend to be bullish signs for a stock because, as a general rule, when these folks invest in companies they should generally prefer to diversify their wealth away from the one from which they receive an income.

However, both of these insiders have already seen good returns on their investment -- so does the stock have further to rise?

Let's look a bit deeper. Late last month, Callaway Golf reported disappointing results for the third quarter. Net sales were down 15% from the prior year, and with operating expenses showing little change, net losses increased by 37% (to $89 million from $65 million). This has reversed the somewhat more positive trend that the company had seen in the first half of the year, as net sales are now about flat for the first three quarters of 2012 vs. last year. Still, even with the poor quarter, net losses are still half of what they were. The decline in third-quarter revenue was led by sales generated in the U.S., Callaway's largest market, and in Europe. Revenue from the rest of the world came in about even with last year's numbers.

Analyst expectations call for losses to continue for the next few quarters, with Callaway seen coming very close to breaking even in 2013. Chuck Royce's fund owned 3.8 million shares of the stock at the end of June, a small increase from its position at the beginning of April. However, other market players are quite bearish, with 11% of the shares outstanding held short, as of the most recent data. We like that insiders are expressing confidence in the company, but we wouldn't recommend buying at this point, given the declining U.S. sales despite a modestly growing economy.

There aren't any publicly held golf-related companies with a sufficient market capitalization to make for good peers, but we can compare Callaway with swimming-pool supplies company Pool Corp. (POOL) and to shoe companies Nike (NKE), Wolverine Worldwide (WWW), and Deckers Outdoor (DECK). All four of these companies have delivered positive earnings on a trailing basis.

In particular, Pool -- possibly Callaway's the closest peer -- trades at 20x forward earnings estimates, even though its third-quarter income declined 12% year over year. We don't think this one is a good buy, either. Nike also suffered an earnings decrease of 12% over the same period, but it obviously has a very strong brand name and market position, and carries trailing and forward P/E multiples of 21x and 16x, respectively. So Nike might not be a good buy on an absolute basis, but we think we'd rather own it than Pool or Callaway.

The other two footwear companies are cheaper; Wolverine has P/E multiples in the teens, while Deckers actually trades at 8x earnings on either a trailing or a forward basis. Both of these companies have seen earnings fall, as well, and Deckers' decline was particularly steep. Further, more than 40% of its shares outstanding were held short as of reports from mid-October. So we'd avoid Wolverine and Deckers, as well.

It's good to be informed about the insider purchase at Callaway, but even taking that into consideration, we don't think this stock is a good value. The company is even expected to lose money next year, given an anticipated improvement in its business, and it hasn't been improving much recently.

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