NEW YORK (CNN/Money) -
Spring is almost here which means that millions of golfers will be excited to once again hit the links on a regular basis. That should be great news for Callaway Golf.
But like many a hacker, Callaway has often found itself in the rough lately.
The company, known for its Big Bertha line of clubs and golf balls, has posted two consecutive quarterly losses due to inventory woes and is expected to report a third consecutive quarter of year-over-year sales declines in April. As a result, shares of Callaway (Research) are trading about 33 percent below their 52-week high.
Callaway is also having a leadership problem. Founder Ely Callaway died in 2001 and his replacement as chief executive officer, Ron Drapeau, resigned in August due to last year's problems.
Nonetheless, analysts are optimistic. According to Thomson/First Call, analysts expect sales to start increasing again in the second quarter and that they will grow 4 percent for the full year.
In addition, pro forma earnings, which exclude one-time charges, are expected to surge 445 percent to 60 cents per share. Of course, the reason for such gaudy growth is because last year was such a disaster.
But if Tiger Woods can have an off year, so can Callaway, right? Will the company bounce back this year or is the company destined to remain in Wall Street's sand trap indefinitely?
Inventory management below par
Golf equipment is tougher to peddle during the winter months and that partly explains the problems the company had at the end of last year. The bigger issue though is that it appeared Callaway overestimated demand after a strong first quarter of 2004 and wound up saturating the market.
Sales surged 34 percent from a year earlier and the company continued to produce equipment with the hopes that this level of demand would continue. It did not. And Callaway can't easily keep old equipment in a warehouse with the hopes of selling it later.
"You have to keep developing something new," said Dennis McAlpine, analyst with McAlpine Associates.
Mike May, spokesman for Sporting Good Manufacturers, said that many golfers are happy to spend more on new equipment if they feel it will better their performance. So manufacturers must present their clubs as cutting-edge technological must-haves.
The company found a short-term solution for the problem...but at the expense of sales and profits. Callaway not only slashed prices but gave clubs away to retailers, according to Casey Alexander, analyst for Gilford Securities.
A mulligan in the form of a takeover?
Who will top the leader board at Callaway? That's a question many investors want answered.
Acting CEO William Baker is heading the company on an interim basis until Callaway finds a permanent CEO. But given the leadership vacuum and the fact that the stock has sunk like a golf ball splashing into a water hazard, some think a takeover could be on the horizon.
"If you were going to acquire Callaway, the best time to do it is when the executive suite is vacant," said Alexander, who mentioned Reebok International (up $0.21 to $43.98, Research) as a possible buyer. Reebok produces some golf apparel but is not a big player in the golf equipment industry.
But investors should be wary of buying the stock just because Callaway might be bought. Takeover rumors are nothing new for this company. Even when Ely was alive, Nike (Research), which does have a big golf equipment and apparel business, was often mentioned as a possible acquirer of Callaway. Callaway did not return calls seeking comment.
Missing the green
All in all, we wouldn't be betting on a big recovery in Callaway's shares anytime soon. It remains to be seen if the company has successfully dealt with its inventory glut. In addition to those concerns, Callaway is facing increasing competition from numerous suppliers of golf equipment, including Nike and Fortune Brands (Research), which owns Titelist and Cobra.
Callaway is also battling counterfeiters, who crank out illegal knock-offs in Chinese factories. The company announced in February that Chinese authorities raided four factories and 18 retailers that were warehousing millions of dollars worth of counterfeit golf clubs, balls, bags, shirts and accessories.
The company's stock, trading at 22 times 2005 earnings estimates, may not seem that expensive. But after this year's expected big jump in profits, earnings growth should cool off. Analysts are predicting just a 10 percent annual growth rate, on average, for the next five years.
Plus, nearly 13 percent of the company's available shares outstanding are being held by short sellers, who bet that a stock will go down. That's not an insignificant amount.
It's true that the company may be vulnerable to a takeover which could give the stock some short-term juice. But given the numerous risks, investing in Callaway is probably as wise a move as using a Big Bertha driver on a miniature golf course.
Analysts interviewed for this story do not own Callaway and their firms do not have banking relationships with the company.