Hot Topics Won't Stay Hot for Long

May. 1.09 | About: Hot Topic, (HOTT)

Trading at a P/E of 24.3 is outrageously high for this specialty retailer whose sales revenue is highly dependent on what is left of teenagers' fickle discretionary spending dollars. Hot Topic (NASDAQ:HOTT) owns two retail concepts: Hot Topic and Torrid. Hot Topic is in the business of selling music-related apparel-T-shirts, hats, shoes, jewelry and other trinkets, often licensed by popular musicians. Hot Topic tailors its products for shoppers 12-22 years old.

Operating since 1989, Hot Topic has since grown to a massive 683 locations in the U.S. - probably close to saturation.Torrid is HOTT's second retail concept. Torrid sells apparel, lingerie, shoes and accessories to plus-size females generally between the ages of 15-29. Torrid's weak same store sales numbers indicate that selling to such a specific demographic is risky.

Even though HOTT's popularity has passed its peak, it has persisted in reinvesting practically all of its cash flow into store expansion - not a good idea when a recession/depression is upon us and consumer dollars are tight.

Hot Topic has no debt, but it has $405M in operating lease and purchase commitments. Included in this amount, it must spend $58 million in contractual rent and $56 million in inventory purchases. Rent costs the company about 8% of sales - a heavy burden for a retailer with 35% gross margins.

Analysts are forecasting a very robust 50 cents per share in earnings for the year ending January 2010. Considering the threat of Wal-Mart (NYSE:WMT) and other retailers eating into Hot Topic's Twilight (that horrible vampire movie) merchandise sales, analysts should lower their earning estimates to match the rough retail environment.

Recently, HOTT granted stock options - options to purchase 570k shares at a strike price of $9.56 per share - to its senior management team. This amounts to 1.3% of the entire company's value given away to management as compensation. This is a severe dilution relative to the value added by management.

Looking at the daily charts, there are obvious divergences in volume and stochastics as prices slowly climbs up, which I suspect is due to a short squeeze. However, I don't expect the stock to stay hot any longer, HOTT should tank sooner rather than later.

Disclosure: I hold HOTT in my stock portfolio on kaChing.