Hot Topic HOTT
August 31, 2000 - 9:42pm EST by
2000 2001
Price: 14.16 EPS 1.62
Shares Out. (in M): 10,647 P/E
Market Cap (in $M): 0 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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  • Retail
  • winner


I’ll probably get slammed on this but who gives a rip? Not I. These are my favorite ‘value ideas’ - reasonable price for dynamic growth and EXTREMELY visible.

My final idea for the year (I’m full of it) is Hot Topic, the weirdest place I’ve ever seen in retail. The K doesn’t do it justice, but this tiny (abt 1500 sqft) is your appropriate hangout for the kid who enjoys leather outfits, moderately offensive t-shirts, and accessories which use trade names like ‘morbid’ (I’m not making this up). Sales attendants generally have a goth look - black hair, black clothes, black (you get the idea). My wife refused to go in the place, and my inlaw couldn’t even figure out what they did from the annual report. I mentioned that to the CFO and his response was that the store wasn’t designed for her but for our (heavens forbid) kids.

Ok, if you are still reading this, here’s why I love the stock:

· Nice BS. Use the K to make it easier (the BS will look better end of this year) - they ended last year with twice as much cash as total liabilities. Growth is entirely self-funded.

· Big unit counts, and growing. Here’s a history:
2Q00 247 (25% higher thanQ3 last year)
1Q00 224 (22% higher than Q2 last year)
4Q99 212
3Q99 198
2Q99 184
1Q99 168
4Q98 158
3Q98 145
2Q98 133
1Q98 123
4Q97 108

· Store economics. ROI for stores is now about 100%. Yep, paid for in a year. That’s 12 months friends. Oh, and since the history of this chain, they’ve NEVER closed a store. NEVER. Per the K: costs $170 for the store, $65 for inventory, $20 preopening.

· Unit expansion plans. Plans are for 50 stores a year, with saturation seen at 500 to 600 stores. That’s 5 to 7 years ahead, though the stores could do for a large base so there could be more upside in selling space. Eventually they’ll need to develop another concept.

· The valuation. Sells for 17.4x trailing earnings. Take out the cash from the cap and you get about 10% of the cap in trailing cash flow. No, it isn’t free cash flow, but with store dynamics like this you don’t want to plow it back in?

· Recent history. EPS doubled in the past quarter. Total sales up 57% (yep, 57%) in the past 30 weeks with SSS up 21.9%.

· Top Management. Insiders have about ¼ of shares. What made me buy this a year ago or so was the background of these folks. The recently stepped down CEO was a former Senior VP of Federated Department Stores' Children's Place and Accessory Place divisions. Another is a former investment banker with ML. The list goes on - the credentials are impressive. This is no fly by nighter.

What to hate:

· SSS comparisons. They are simply brutal, and when (not if, but WHEN) SSS go down - POOF - there goes 50% of the market cap in a day or week. That’s what happened in 98 (oh, and the company bot shares then - they know opportunity when they see it). So don’t bet the farm here. This is one of those stocks for a ‘diversified portfolio’. That said, what happens if SSS are sustained at a upper single next year? Could happen…

· This is ‘just a trend’. Yadda, yadda, yadda. So what else is new? What, you think Gap doesn’t go thru cycles? No, I wouldn’t shop in a store like this, but other folks do. The longevity of the chain (since 89) should give you some hope. And the very oddness of the chain enhances its niche appeal - I suspect nobody in Limited Express is buying black shirts and jewelry. Who else is gonna model themselves after them? Retail is all about trends, and nobody (except WMT and HD) is immune.

· Yo-yo stock price. Bad news, it goes down. Good news, it goes down. That alone seems consistent. Deranged monkey behavior characterizes this stock. In the meantime, it can experience explosive appreciation as mo players move in and out of here and there. Gotta love it! Trade it, by all means - as long as SSS continue in double digits, the more volatility the better IMO.

Mo players aren’t the only ones who play here - you’ll see oft-times retail investor Jeff Vinik (geez did Fido screw up with moving him out, eh?) in this stock too, so don’t worry too much about the company you keep. I bet Lynch himself would have loved this (maybe even more 12 months ago!). After all, it is a well financed fast grower in the mid life growth phase selling at a valuation which is far lower than the over market while experiencing current growth 5 to 10x (I forget what the SP500 is doing these days) higher and possible future growth of 15% to 20%, if not more.

I’m outta here. Six ideas and you get the boot. The last thing I’d do with my clients is put them in one of two or three or four stocks….give me 50 ideas and I’ll be happy. Call it a zoo if you will. As long as each is a knowledgeable investment, ‘the more stocks you own, the more flexibility you have to rotate funds between them’.

From Peter Lynch, the greatest value manager of our time.


Inevitable rotation of momentum investors drawn by 100% eps growth and 20% comps
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