Cramer Cranks Up the Heat on Laggard Hot Topic

On Tuesday’s Mad Money, Jim Cramer dressed in a ridiculous get-up in an attempt to resemble an oft forgotten spending giant, the American teenager. He calls the American teen “the most coveted shoppers out there; free spending, impulsive shoppers, who are totally unhampered by debt and don’t have bills to pay and can spend all day being mallrats.” Teens are hitting the malls again, which has been great news for such retailers as Aeropostale (ARO) and American Eagle (AEO), but those stocks have nearly doubled since the market bottomed last year. Instead, Cramer focuses on a much less loved teen retailer Hot Topic (HOTT), which coming into the day was even lower than where it was early last March.

According to Cramer, the strength in this group is real and HOTT could be a smart play as its stock will tend to catch-up with the rest of the group. He used this company as his subject of Off the Charts segment where he utilizes both technical and fundamental analysis as a basis for an investment thesis. The HOTT chart is telling investors that this company is ready to soar much higher, and technical analyst Dan Fitzpatrick says the stock is in a bullish trend because of new buyers’ demand for the stock.

Fundamentally speaking, there is a lot to like about the stock as well. Cramer points to the $1 special dividend Hot Topic announced last week and they also announced a regular dividend which as of the time of the announcement constituted a yield of 3.3% right off the bat. That is a strong signal of confidence from management, and initiating or hiking a dividend is always a positive factor in our analysis.

Management has been taking steps to improve operations by reducing inventory and focusing on core brands in order to lessen the impact of pop culture cycles (such as sales gains from Twilight merchandise). Building a more stable and sustainable product line is a major goal of the company and the consistency that could bring would benefit shareholders.

Now, the date to own the stock in order to receive the huge special dividend was today, but if you missed it the long term prospects are still very enticing. For example, historically Hot Topic has traded for a price-to-cash earnings multiple of between 7.6x to 16.5x over the last ten years, but the current metric is barely over 7x cash earnings per share. Furthermore, price-to-sales of .52x compares favorably to the historically normal range of .65x to 1.41x sales per share. The current fundamentals appear attractive compared to historical norms, and we believe the stock will trade between $9.50 and $14 per share in the coming year.

Recently analysts have started to ratchet up their earnings estimates for the current quarter thanks to the resurgent teen shopper, but to some, current EPS estimates do leave something to be desired. The company trades at about 35x this year’s expected earnings per share ($.28). However, if you subtract the $2.77 per share that the company had in cash on hand as of its last report (no long term debt), the current P/E is a much less dubious 25x.

We are reiterating our Undervalued stance on HOTT as of this week’s report. The company is seeing improving business trends, and they are priced attractively compared to peers. The balance sheet will remain strong even after the mega one-time dividend, and the newly initiated regular dividend is also impressive. The stock traded 15% higher on Wednesday, thanks in part to the special dividend, so we would advise waiting for a pull back before buying. But even if you missed the special dividend, we agree with Cramer that this stock has a great opportunity to catch up to the performance of some of its closest competitors.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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