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Friday, April 23, 1999

FOOL ON THE HILL
An Investment Opinion
by Warren Gump

Some Sporty Stocks


Sport and athletic company investors have had a harrowing rider over the past couple of years. One-time high-fliers, garnering the glory of Olympic champions, these stocks have been sabotaged by the one-two punch of shifting consumer spending and investor dissatisfaction that is more powerful than an attack planned by Tonya Harding and her cohorts. Some of these companies will never recover from the carnage, as industry turbulence combined with excessive debt, faddish products, or a non-dominant brand prove to be a lethal combination. Better managed and stronger companies, however, should see a prosperous future. As boomers and their kids enjoy higher incomes and lead more active lifestyles, some of these firms should earn substantial returns in the decades ahead.

Virtually no segment in athletics appears to be immune from the recent carnage. Hardest hit have been footwear and athletic apparel markets. Both retailers and manufacturers have struggled as consumers slowed their purchase of athletic shoes and shied away from athletic apparel. The golf segment has been equally dismal, with leaders like Callaway Golf (NYSE: ELY) taking a drubbing as sales plummeted first in Asia, then in the States. Makers of inline skates have seen their industry take a turn for the worse, as industry growth was easier to stop than skaters themselves. Even the ski industry has been knocked down over the past year, with warm weather raining on this year's performance.

The two biggest players in the athletic shoe segment have addressed problems in their industries similarly by restructuring to cut costs. Nike (NYSE: NKE) appears much further ahead of competitor Reebok (NYSE: RBK) in these efforts. Both firms experienced earnings declines of 60%-65% last year. Looking into calendar 1999, however, analysts expect Nike's earnings to rebound 68%, whereas Reebok is only expected to have a 40% bounce.

Reported results for the latest quarter indicate Nike experienced a sales decline of 2% and a jump in net income of 70%, while Reebok suffered from an 11% decline in both sales and earnings per share. Nike's efforts to rein in costs and reduce inventories have been much more successful than those of Reebok. In addition, the massive marketing and distribution system of Nike seems to be better able to maintain sales than its Beantown competitor.

Making Nike even more attractive as an investment is its stellar balance sheet. The company has long-term debt and notes payable equal to only 29% of shareholders' equity. Reebok, on the other hand, has debt equal to 131% of equity, thanks to debt assumed for a massive 17 million stock repurchase at $36 per share in 1996 (the stock is now $18 15/16). While Nike can reinvest most of its cash flow into new product development, marketing programs, and acquisitions, Reebok is still plowing most of its cash flow into covering interest payments and reducing its debt burden.

If you prefer to stay away from the athletic shoe makers, you might want to take a look at Timberland (NYSE: TBL). This shoe and apparel maker has reported increasing revenue and earnings for the past 11 quarters, thanks to limited exposure to Asia. Having been implicated with other footwear companies, Timberland's stock is down almost 20% over the past year, although it is actually up over 50% so far in 1999. Despite the recent run-up, the equity still trades around 12x this year's earnings estimates. Balance sheet watchers will be impressed with this company, as it has $123 million in cash and only $100 million in debt. Inventory control, an always-present issue for shoemakers, seems to be improving, with days sales outstanding decreasing to 73 days from 77 days a year ago.

Shoemakers are not the only athletic companies that have been taken out to the woodshed by investors. Companies with businesses related to golf have also been knocked out. Callaway Golf has seen its stock plunge from a high of $38 to today's $13 7/8. A slowdown in Asian sales was exacerbated by turbulent conditions in the domestic marketplace as competition intensified. Having begun a diversification into numerous other golf-related businesses besides clubs, Callaway has narrowed its operations. In a restructuring announced last November, the company cut 24% of its workforce and exited the golf book publishing, interactive golf sites, and driving range businesses. Plans to offer a new golf ball are still proceeding.

Despite the disastrous results from last year, when operating profit fell to $0.45 from $1.95, the company still has a fairly healthy balance sheet. The company has no long-term debt, although it has borrowed $71 million on a line of credit. Shareholder equity stands at $463 million or $6.03 per share. The biggest concern on the balance sheet is inventory, which increased 53% over the prior year. With sales down 17% last year, that doesn't sound good. It wouldn't be surprising to see Callaway reduce prices further to clear out excess products.

One item worth pointing out is Callaway's dramatic increase in research and development (R&D) spending over the past two years. As the company prepares to launch its new golf ball, this expense has more than doubled. Myopically focused companies often slash R&D spending to boost short-term profits and meet profit projections. Callaway, however, has determined that this business is a key growth area that should not be slowed down. While I can't tell you if the product will be successful, I prefer investing with companies that consider the long-term ramifications of decisions more important than meeting an earnings estimate.

Alas, I've written too much and only discussed a few companies in the sports-related arena. Many others may be worth further evaluation. In footwear retailing, Sports Authority (NYSE: TSA), Venator (NYSE: Z), and Just for Feet (Nasdaq: FEET) all have been stomped. All three publicly traded ski resort companies, Vail Resorts (NYSE: MTN), American Skiing (NYSE: SKI), and Intrawest (NYSE: IDR) have suffered from this year's bad weather and been shunned by investors. Inline skate, bike, and skiwear maker K2 Inc. (NYSE: KTO) is down over 50% from its 52-week high and selling below book value. Bike manufacturers Cannondale (Nasdaq: BIKE) and Huffy (NYSE: HUF) have both experienced deflated stock prices.

Further investigation will reveal that some of the depressed prices are justified. In a few cases, however, you might find an opportunity to buy some of these companies at reasonable prices.

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