Below you will find a sample recommendation from a back issue followed by some market commentary and several sample updates. Issues run from 8-10 pages in length, depending on the recent developments at each company. The first two pages are devoted to a new stock recommendation as below, the remainder of the issue is devoted to detailed updates on every stock previously recommended until it is sold.
Celebrating our 19th year
P.O. Box 133, Redding, CT 06875 September 22, 1999
Year 19, No. 7 DJIA = 10,804
Hot Topic
(HOTT $26.56 [$13.28 after 2:1 split*], NMS)
Year End January 31st, 1997 1998 1999 2000E 2001E
Revenue ($ millions) 44 71 103 155 200
Net Income ($ millions) .6 4.5 6.0 9.8 12.7
EPS, diluted ($) pre-split .66 .92 1.21 1.95 2.45
Avg. Diluted Shares (mil) 3.9 4.9 5.0 5.0 5.2
*Note 1/12/00- HOTT split 2:1 on 12/27/99; estimates for FY1/00 and FY1/01 are now increased to $1.25 and $1.60
There are about 31 million teenagers in the US currently and that number is expected to swell to 35 million during the next decade. That's almost double the growth rate of the population as a whole and makes teens one of the most rapidly growing demographics around. And teens today have deep pockets. They spend nearly $120 billion on themselves annually. Hmmm, the wheels are turning now… on what? Well, if you ask teenagers how they spend their free time, outside of school and sports, high on the list will be listening to music. Also high on the list- going to the mall. Over half of all teenagers go to the mall once a week to socialize, shop or work. And what most inspires what they wear? Again, high on the list is music. In 1988 Orval Madden founded Hot Topic, a retail store concept specializing in music influenced apparel, accessories, gifts and music geared to tapping in to all of the above. He realized that none of the teen retailers took their inspiration from teen music. Perceiving the importance of music in determining the current fashion trends with many teenagers, he opened the first store in Southern California that year and today there are 191, with 208 planned by year-end (1/31/00).
In 1996 Hot Topic went public (at an extreme PE multiple of around 100), issuing 1.5 million shares and raising $26 million dollars. With no further financing the Company still has $24.6 million of it left and no debt. The rock steady advance in sales and earnings above is a thing of beauty and attests to the success of the concept, and I don't just mean since 1996. I have numbers back to 1991 (ended 1/92) when sales were $2.9 million. In '92 they grew to $6.4 million, then $9.8 million in '93, $14 million in '94, $23.6 million in '95 and from there you can finish the decade in the table above. Profits grew just as steadily (with the exception of '93). All this indicates Hot Topic has long term staying power. Despite historical growth well in excess of 30% (60% in 1999 YTD), the shares trade at just 14 times projected current year earnings of $1.95, making these shares way undervalued by any measure. In fact, Hot Topic is in the top 1% of all companies for its relative earnings growth. While the market has been cool on retail stocks lately due to rising interest rates (an unlikely relevance to Hot Topic), HOTT has doubled from its depressed level at the end of last year and the shares carry a relative strength rating of 86. The BI Rank likes all this and rates the shares 9.4, solidly in the Buy zone.
The Company
Teen music is where Hot Topic planted its roots and it remains the driving influence in everything the Company does and sells. Hot Topic stores run about 1,500 square feet selling over 12,000 sku's (stock keeping units) across 26 categories. Last year's sales/store averaged $772,000 and $542/SF (the latter is better than The Gap). Stores mature in a matter of weeks and have a 90% ROI on the initial investment of about $260,000. Stores are usually profitable in their first quarter and pay back in less than 14 months. The Company spends little on advertising, instead using the mall as the draw and good/expensive storefront locations within those teen meccas. Stores are designed to serve as the main source for music licensed and music influenced apparel (48% of sales), accessories (26% of sales), gift items (19%) and other (7%). Within each category the Company's strategy is to offer a broader assortment of merchandise than is available at any other mall location. For example, in the apparel category T-shirts rule. Over 100 different licensed band T-shirts are carried in each store from rock artists such as Pink Floyd, Jimi Hendrix, the Doors, the Beatles, Led Zepplin and others to alternative artists such as Korn, Limp Bizkit, Deftones and Blink 182 (huh?). Other categories found in the stores include caps, pants, dresses, outerwear, posters, music videos, CD's, weird shoes, socks, sunglasses, jewelry and cosmetics. Some of the stuff is very benign. For example, they sell T-shirts and other items related to Pokemon and other cartoon characters for the younger crowd. In between you might find a T-shirt that features a skeleton playing a guitar or one popular with girls that says, "boys lie." On the funky end of the spectrum customers can find leather clothing, puma prints, and rock band T'-shirts. Hot Topic also has 4 lines of its own private label merchandise, which accounts for 20% of sales. In short, HOTT has carved out a very successful niche that overlaps very little with other retailers.
A job description for some employees at Hot Topic might well read, in part- "Candidate must watch MTV and attend as many rock concerts as possible and report on what people are wearing." The Company is also attuned to the latest in pop culture (with past and present examples including Pokemon, Buffy the Vampire Slayer, South Park and Professional Wrestling). New items and categories are tested at a few stores and only rolled out nationwide if they sell well. The Company likes to be ahead of the fad/fashion curve, being very quick to jump on a puma print being worn by Korn, for example. Two months later it's selling well in its stores. HOTT was also at the head of the line in recognizing the South Park phenomenon in 1997, but habitually moves out of such fad items by the time such merchandise begins appearing elsewhere. In fact, that one created such a surge in Q4 1997 sales that, when the Company couldn't match it last Christmas season (comps were -7% for November and December 1998), the shares took a big dive late last year from which it took six months to recover. This is something perhaps still reflected in the current PE. Another seasonal phenomenon is Halloween. Hot Topic had begun to see that its stores were benefiting from a Halloween spike because of some of the stuff it sells (including Morbid make-up, band T-shirts with skeletons and skulls on them, etc., and 10% of sales come from what the Company calls its Gothic side). So it began playing to that more in 1998 around Halloween and that created a very impressive comp store gain in October 1998. The Company expects to improve upon that this year. Indeed management has proven that it is capable and experienced, but is still learning ways to improve its formula. A recent addition from Claire's has helped the Company "focus more attention on comps." The Company also sells 1,800 items through its recently revamped web site, which is growing rapidly but doesn't yet account for a significant part of its revenue stream.
It is worthy of note that Hot Topic has never had an unprofitable store nor had to close a store due to poor performance, a further testament that their curve leading, music driven, teen retail strategy is a winner and has been for over 10 years. Today it is only gaining momentum. Comp store sales managed a gain of 16% in July and topped that with a 20% comp store gain in August! The back to school season this year was huge, but those comp results are not expected to continue (5% to 6% is targeted). YTD comps are up 17% and sales are up a whopping 61%. Stores are a little slow after school starts and on into early October, but pick up around Halloween, then again just before Christmas. During school hours, stores can be lightly staffed. Summers are good with school out (and kids are earning money), leaving January through May as the slower time of the year. Nonetheless, Hot Topic is quite profitable in all four quarters.
It should be noted that the retail sector has been going through a period of correction in the last month or two, with investors worried about the perceived dampening effect of higher interest rates on retail spending. But this just spells opportunity for new long-term investors. Teen spending on small ticket items like music inspired T-shirts and accessories by Hot Topic's target market of 12 to 22 year olds is unlikely to be significantly affected. And, since the Company is in an enviable surplus cash position with no debt, higher interest rates will only mean higher interest income. (With only 5 million shares, buying back stock is not an option.) Hot Topic is not far off its high of $31, and is very attractively valued at a current PE of 17 times trailing earnings, 14 times current year earnings and 11 times next year's earnings, despite sales growth of 60% YTD and long term projections of 30% growth. HOTT is a strong Buy up to $32. As always use limit orders. Investor Relations- (626) 839-4681 (CA) www.hottopic.com
UPDATE
The market has held steady since our last update. The hot topic now is what the Fed will do with interest rates. One day some figures come out that fan the fires of fear and another day other numbers come out that seem to indicate no further hikes are necessary. Most recently the latest jobs report indicated only 124,000 jobs were added in August, half the expected rate. Also, the CPI was up just 0.3%, and without food and energy up just 0.1%. This made investors think that perhaps there would be no further boost in interest rates for now. But investors may be missing the real point here. What I think is going on is that Mr. Greenspan is using any hint of inflation as an excuse to hike interest rates, not so much to cool any hint of inflation as to cool off the raging stock market. By almost any measure the stock market is at its richest valuations in history. Basically in many sectors we have a speculative bubble, especially in anything Internet related, from Cisco at 80 times earnings to Amazon.com which trades at $66 despite five years of losses and more of the same forecast for next year. One pundit recently figured out that the market has not closed below the low of the previous year for 17 years now.
The increase in wealth that has been created by the combination of excessive valuation and the lengthy bull market has gone a long way to fuel this extended period of economic prosperity. But with the popular stocks at such lofty levels, if the bubble gets pricked and it all comes undone, the Fed may not be able to bring the economy in for a soft landing. All the consumer spending and consumer confidence coming from stock market gains, both realized and paper, could evaporate just like that and the economy could actually be plunged into a recession by the drop in the stock market itself, and not the other way around. The Fed has basically indicated recently that it will continue to hike interest rates until it deflates that bubble. For now, I think upside is rather limited while the downside is considerable. Said one analyst, the market could drop by 50% and still be above historical levels of valuation. I should clarify here that I am not referring above to smaller cap stocks, which are actually undervalued, but to the popular mega-caps that dominate the popular market indexes. With seasonality continuing to work against us through October, I continue to recommend only a 60% invested position. Currently most attractive for purchase in addition to Hot Topic are Jones Pharma, Envoy, Albany Molecular, Dycom, Great Basin Gold, and Janus Mercury and Worldwide funds. CenturyTel remains on a short leash with a Sell at $44.
PERIPHONICS* (PERI $30.44, +58% ); Sold at $27.75, +44% via Update Line 9-7-99 (516) 464-0279 NY (Recommended 8/99) www.peri.com
Well, that was a quick ride. Within weeks of BI's recommendation, Periphonics received a stock for stock takeover offer from Nortel that equated to $29.23, as long as Nortel traded between $38.46 and $47.15. Above that range the exchange ratio was set at .62 times the Nortel share price. But Nortel, which was snoozing along at $43 at the time, has been strong in the past two weeks and is now trading at $49.75, up $1.44 on Friday. So if you didn't check the last regularly scheduled Update Line and sell the stock already, you can do even better now. PERI closed at $30.44 Friday, up 58% from our recommendation price just 6 weeks ago. Nortel's strength is in part due to Merrill Lynch's recent inclusion of NT in its list of top 10 technology stocks for the year ahead. Also, Value Line ranks Nortel 1 for year ahead performance. So if you haven't sold yet, there is that to consider as well. But Nortel has $22 billion in sales and this is way out of BI Research's focus of small to mid-cap stocks, so we will not be following it- Sell.
JONES PHARMA* (JMED $28.88 NMS, +86%); BI Rank = 8.4 - Buy to $30 (314) 576-6100 MO www.jmedpharma.com (9/98)
Jones Pharma is another stock I hope to make a core long term holding. As I have discussed in the past, Jones has been very successful in acquiring new products that it can grow organically by 20% per annum, or better. Not fully appreciating this at first, I spent my first 6 months asking when the Company would make another new product acquisition, but after seeing quarter after quarter come in at 25 to 30% growth without one, I realize now that this is an internal growth story, not an acquisition play. And the Company is making every effort to have investors see that as well. Indeed, this is clearly the preferred growth avenue. Earnings estimates for the year are now creeping above $1.00 (recall the shares recently split 3 for 2) vs. $.77 last year, with $1.20 to $1.25 expected for 2000. Driving these earnings most notably are Thrombin whose sales should increase from $18 million in 1998 to $27 - $28 million this year and Levoxyl which has now captured a 29% market share… up from 26% last month. It works as well as Knoll's Synthroid at a fraction of the cost. The Company just raised prices on that one 11%, but is still far below Synthroid. Cytomel, which we have discussed in past issues is getting some good press and is doing great. Meanwhile, the cash stash (now $150 million) just keeps growing, with operations generating about $10 - $12 million per quarter. This is a favorite- Buy to $30.
DYCOM* (DY $38.13 NYSE, +123%); BI Rank = 8.1 - Buy to $39 (Sold 50% at $32.54, +90%) (561) 627-7171 FL (10/97)
Since our last update Dycom reported that EPS for the July quarter surged 66% to $.53, or 44% to about $.46 excluding a favorable insurance expense adjustment (they had over accrued in the first 9 months), handsomely beating estimates of $.42. Revenues soared 42% to $144 million. Full year EPS weighed in at $1.53, up 52%. But Dycom has seen its share price roller coaster since the last update, due to events, including the above, that have been well documented on interim updates on BI Research's Update Line. The Update Line, again, is there for exactly this purpose- to cover significant events between updates. Basically, the other event was that a self proclaimed watchdog group called the "Center for Financial Research and Analysis," CFRA, for whatever reason, decided to highlight/question certain levels of assets on Dycom's balance sheet. I wasted two days on this nonsense and ultimately wrote a 4-page airing of the issues CFRA trumped up, except that I include the rest of the story and the explanation. My beef with CFRA is they made little or no effort to figure out or explain why things were changing as they were on the balance sheet. They just tried to paint as negative a picture as possible, for what reason I will leave to your own imagination. You can still call the Update Line (the number is always at the bottom of the last page of each issue) and then press "1" at anytime before the current update is finished playing to jump to this lengthy explanation I have prepared. Or you can save phone money and email us at BIRstocks@aol.com to get a copy emailed to you. In essence, after a lengthy analysis of CFRA's comments, I find no reason to be overly concerned and am satisfied with the Company's answers to this self appointed investor watchdog group's issues. Dycom didn't deserve this. You didn't deserve this. I didn't deserve to have to waste so much time on it. But, we move on. Business remains robust, the Company is still beating analysts' estimates and the BI Rank is still in buy territory at 8.1. Accordingly I feel comfortable with reiterating a Buy to $39.
ALBANY MOLECULAR* (AMRI 24.44, -18%); BI Rank = 7.1 - Buy to $28 (518) 464-0279 NY (Recommended 6/99)
Albany Molecular is acquiring privately held EnzyMed for $20.6 million. Though AMRI has about $45 million of cash and investments, it is doing a pooling of interest. As such, the Company is using its stock and has to restate its EPS for EnzyMed's results retroactively for the year to date. As a result, EPS will come in closer to $.88 than the $.93 - $.94 I was expecting for 1999. The deal should close by the end of October. The acquisition will hold back Q4 some, but starting next year that dilutive effect will become neutral and then become increasingly accretive as the year goes on, so that for next year overall, which begins in 4 months, the acquisition is expected to be accretive. Why the sell off is beyond me and the Company, though down seems to be the prevailing direction that a stock goes when it makes an acquisition. It was down $3 points after the announcement on a mere 11,800 shares (nice market making guys!) and only 24,000 shares traded all day. So it is not like there was a mad rush to the exits, just a lack of buying at a time when there were a few sellers. After that, the stock marked time for a day or two and then inexplicably plunged $5 points last Tuesday, for no reason that the Company can uncover, despite dozens of phone calls. This is unusual. There is almost always a reason for such a decline. But in this case none can be determined, fundamental or otherwise. There were simply no buyers to absorb 120,000 shares of selling.
The Company says it now plans to be much more active again in talking to the investment community to raise the level of awareness, something not necessary when the stocks was trading over $30. Both analysts (ING-Barings and HQ) have come out reiterating their buys on the Company since the proposed acquisition of EnzyMed was announced. The shares now trade at about 17 times 2000 earnings of $1.16 to $1.20. The Company issued a press release the morning after the stock dropped to $20.50 giving some more details on the acquisition, what a good fit it was and stating for the first time that it was expected to be accretive to year 2000 EPS. The Company confirmed everything fundamentally is looking good, expansion/renovation of lab facility space in the old Sterling Winthrop facility from 16,000 SF to 40,000 SF continues, hiring is ahead of plan and they even reeled off a number of sizeable contracts that have just been signed or are in the works. Incidentally, to avoid something like this the Company has been involved in finding buyers when any sizeable blocks came up for sale, since the stock can trade thinly sometimes. Any true investor has to be looking ahead to next year, not backwards and on that basis AMRI looks even better than before, so I continue to rate the shares a Buy to $28.
TJX COMPANIES* (TJX $30.06 NYSE, +21%); BI Rank = 6.6- Hold (508) 390-1000 MA www.tjx.com (7/98)
Though TJX says it is shooting for growth of 15 to 20% each quarter, in fact it has had 14 straight quarters of EPS growth that exceeds 25%! Comps for August were up 5% over last year and 6% YTD. Sales in total were up 11% in August and also for the year to date. Meanwhile, EPS estimates have crept up again from $1.60 to $1.65 now. In my original recommendation of TJX back in July 1998, I was looking for $1.35! All the intervening upgrades, EPS surprises and steady earnings growth have translated into a 21% gain in the shares since then. But a snapshot 2 months ago would have shown the shares bumping against $35 and a more noteworthy gain. However, something has happened in the past two months to retailing stocks which have slipped into somewhat of an investor malaise. The conventional wisdom is that this was due to Greenspan's actions with interest rate hikes, and threats of more to follow. His goal, of course, is to preemptively cool off the economy to ward off inflation. But ergo he would slow retail spending in theory. However, TJX has demonstrated very little correlation with interest rates or the economy in general in as much as it is an off-priced clothing retailer. In fact you can argue that economic downturns actually help its business with better buys available to TJX on more surplus inventory and more demand to find better bargains by its customers. But in all fairness, TJX has not taken it on the chin the way The Gap and Abercrombie and Finch have (both had been trading at obscene PE's). Meanwhile American Eagle hasn't come down much at all. I have every hope of making TJX a core long term holding and as such am not overly concerned about this period of relative softness- Hold.
INTERNATIONAL FIBERCOM* (IFCI $7.59 NMS, +1%); BI Rank = 5.5 - Hold Investor Relations: (714) 957-8440 www.ifci.com (8/98 at $7 7/8 & 5/99 at $7 3/8)
Uncharacteristically, I was unable to make contact with anybody at IFCI for this issue. IFCI's EPS estimate went down another $.05 to $.50 since our last update which is really getting tedious now. This was reportedly because even though the delayed jobs (one of the problems with the last quarter) were starting, now there weren't enough heads to do all the work so July was under expectations. That was the first time that fear turned into a reality. Whether this was remedied in August is high on my list of questions. I'm anxious because I can remember when the Company thought, and the consensus was, $.70 for this year (last November), then $.65, $.60, $.55 and now $.50. The CEO, COO and CFO have been unavailable which could mean something is up. Whether it's good, bad or coincidence, I hope to find out soon. I will probably have an Official Update on the Update Line by the time you receive this (Tuesday at the latest).
ENVOY COMMUNICATIONS* (ECG.TO C$7.10 TSE, +75%); BI Rank = 8.4 - Buy (Sold 50% at $8.20, +102%) Investor Relations: (800) 444-9214 www.envoygrp.com (2/98)
Envoy has digested some of its earlier run from $4 to $8+ and has settled in at the lower $7 range. Earnings for the June quarter came in at $.05 a share, up 25% over the year ago level, and the Company forecasted an $.08 4th quarter and $.22 for the year. Revenue for the 9 months, including media costs were $101 million vs. $23 last year. Gross margin, which essentially strips out media costs (the costs of the ads themselves placed in different media), was $28 million vs. $9 million last year. All dollars are Canadian. Net income grew 68%, but the diluted share count grew also (to 14.2 million (9 mos. average), primarily due to acquisitions. EBITDA, a favorite measure of the late 90's investor, grew by 231% to $4.8 million. The recent acquisition of the Watt group brings with it some big name customers, most notably Wal-Mart, but also such names as Safeway and Petsmart. The acquisition broadens Envoy's range of services and its cross selling opportunities. This summer the Company raised $18 million through RBC Dominion Securities, which has since released an 18 page buy recommendation of Envoy with a 12 month target of $10.50 and a FY9/00 projection of $.28. Long term debt is just $3 million as compared to shareholder equity of $36 million. In a recent conference call, the Company noted that a $25 million advertising campaign it is rolling out for National Discount Brokers has already increased new customer inquiries to NDB's site by 100%. Separately Envoy announced the debut of three new television commercials that began airing during the 1999 Grammy Awards in their ongoing ad campaign for CDNow. The 20-F, the first step in filing for NASDAQ listing, has been filed and they are answering the SEC's questions. Hopefully by late this year or early next Envoy will be trading on NASDAQ. The Company remains active on the acquisition trail and has signed confidentiality agreements with several different acquisition targets. Often these target companies would rather merge with Envoy then get lost inside a giant ad agency. So there may be news on that front before yearend as well. All in all Envoy is a great addition to our stable. It is building a name for itself as an integrated e-Marketer with a broad base of traditional and contemporary capabilities, committed to building global brands both off and on-line- Buy to $7.30.
GREAT BASIN GOLD* (GBGLF $1.40 OTC, -84%); BI Rank = 8.5 - Buy to 1.30 AMARC* (AHR.V C$.55 VSE, -80%); BI Rank = NA - Speculative Buy (604) 684-6365 BC (GBGLF- 9/89 &2/96; AHR- 7/96) www.hdgold.com
Great Basin has already drilled six holes and has three more nearing completion out of a total drill program of 50 holes to be completed before year end. All nine will probably be done by the time you get this. They'll be assayed over the next few weeks and by the end of October the Company should be able to release the first assay results. This discovery drilling phase is what really makes the blood pump for veteran investors in junior mining companies. This is when these stocks make their biggest and best moves. The stock made a nice run from $1.00 to the $1.70 - $1.80 level in anticipation as the word started getting around. In the past week or so, GBG has digested some of this big run, which is perfectly normal and is currently trading at $1.40, hopefully for the last time. Even though this is a gold play and gold's price is $257, it's a Ken Snyder look-alike deposit by all accounts and the nearby Ken Snyder mine has a cost of production of under $90/oz. Anything even close to that would make GBG a very attractive acquisition to a major and there are a number of them watching with keen interest. Hopefully, it'll end up being just a matter of who blinks first and GBG will be gone, but it ain't over 'till it's over, so stay tuned. Amarc is up 28% since our last update and is still eyeing several projects on which it has done full considerable due diligence. They've oggled 'em and would like to dance, but each needs a little convincing and negotiation and the beat goes on. I keep meaning to make note of the fact that there is a sister company to Amarc called Anooraq, which I own some shares in and continue to nibble at. They both have roughly C$5 million in the till, so are both all financed and ready to dance. And they have generally traded at the same price, since they are both shells with the same amount of cash. But for some reason Anooraq recently slipped to $.35 while Amarc advanced to C$.60, probably indicating that investors think Amarc is closer to getting a project. And this may well be the case, but individual circumstance will determine which of the two gets the next project. So, playing Anooraq as a catch up play has some appeal here (though it is not officially being added to our stable). Both are interesting speculations on moves over $1 when they get their projects. If it takes 1 or 3 years, that's still a nice return.
JANUS WORLDWIDE/(Overseas) (JAWWX $54.90, +66%) - Buy JANUS MERCURY FUND* (JAMRX $33.02, +3%) - Buy (800) 525-3713 www.janus.com (11/96 & 4/99)
If the truth be told, I can see the power of the Internet, I know it's the greatest thing since the computer itself… but I can't come to grips with the mind boggling valuations of the Internet crowd. I just can't pony up for some shares of AOL or Yahoo at 100's of times earnings. To that extent at least, I have a lot in common with Warren Buffet, and I suspect the majority of investors. I also have trouble paying 80 times earnings for Cisco, but I can see it is the backbone of the Internet; or 65 times earnings for EMS, though I know it's the best thing to come down the pike in storage, and that with the Internet we need a lot more of it… Anyway, just because I can't quite do it myself doesn't mean I don't see that somehow, against all my own fundamental valuation criteria, it works and people that buy these great stocks make a lot of money. So when you need something done that you can't do yourself, you hire somebody else to do it, and that's what I hired Janus Mercury Fund to do. Through JAMRX we own a basket of those Internet stocks, plus Cisco, EMC, Tyco Intl, Nokia, a bunch of cable TV companies, NextLink, Level 3, Viacom, Time Warner and Microsoft. I made up a list of my "Overvalued Dream Team" earlier this year. Many of the names above were included… 8 months later they are "The Even More Overvalued Dream Team…" by about 22%… Janus Mercury Fund and, on a worldwide basis (which includes the US), Janus Worldwide are our tickets to this arena. As such, both are Buys...
...well, you get the idea. Each issue includes a new detailed recommendation an an update, like those above, on EVERY company we have recommended until we say to sell. Generally that's about 10 to 14 companies in each issue.