Catablast's Four Back-to-School Plays

With the summer waning and August just one week away, parents across the country must be thinking one thing: back to school shopping. Spending by the average family with school-aged children is expected to rise 19 percent to $527 from $444 in 2005, according to a recent survey. Even though the retail sector has gotten crushed by higher interest rates and expensive gasoline, we think the following four names could see modest upside from the pending back to school shopping season.

Pacific Sunwear (PSUN): PacSun targets trendy young men and women who are influenced by hip-hop music and the urban lifestyle with name-brand casual apparel (jeans, shorts, T-shirts, swimwear), shoes, and accessories. Stores feature name-brand apparel by Billabong, Quicksilver, and DC Shoes footwear, among others. PacSun also sells its own private-label merchandise (Bullhead, Breakdown, Good Vibes, and Tilt). The rapidly expanding company now operates two Web sites and about 1,100 stores in 50 states and Puerto Rico under the names PacSun, PacSun Outlet, and d.e.m.o. After adding 115 stores last year, PacSun plans to open about 100 new outlets in 2006. PSUN has earned a reputation for catering to teen tastes and even holds a weekly vendor open house where unknown labels have a chance at being the next mega teen trend. We view this anti-establishment theme in a favorable light and would gladly pick up shares at today's depressed levels. PSUN, which has $95M in cash and zero debt, looks awfully cheap: the company has grown its EPS 36% over the last 3 years but currently trades at less than 11 x current year earnings. PSUN looks like one of many retailers whose shares were mercilessly clobbered by rate-phobic investors who panicked after Bernanke opened his mouth.

Hot Topic (HOTT): Goth is in and Hot Topic is cashing in on your daughter's infatuation with black lipstick. The punkish, teen-oriented retail chain, which operates 660-plus mall-based stores in the US and Puerto Rico, coughed up $725M in sales last year. HOTT primarily sells rock-inspired clothing and accessories in settings resembling dark industrial clubs. The retailer also operates 120 Torrid stores for plus-sized customers. Built with the enfant terible in mind, Hot Topic targets rambunctious customers ages 12 to 22. The chain carries hard-to find items, like pinstripe fishnet stockings, skull necklaces, and enticing thong-wear [should we ever find our kids wearing this stuff, we swear we will ground them for life and feed them gruel until they're 40]. HOTT -- which tests new items in a few stores before launching them on a national scale -- is expanding rapidly and plans to open about 40 new Hot Topic stores this year. All that said, with ROE that's 300 bps lower than the industry average, Hot Topic is not a stock we'd buy in a hurry. The stock currently goes for 36 x earnings, which looks expensive when we take into consideration that HOTT has grown its EPS just 14% over the last 36 months. In short, we believe that even the most upbeat forecasts are already baked into the stock, the most speculative bet among the four stocks listed here.

Zumiez: (ZUMZ) Zumiez is a mall-based retailer offering extreme gear to youngsters with penchants for action sports like snowboarding, BMX, skateboarding, and surfing. From about 190 stores in 19 states, Zumiez sells popular youth brands like Burton, Hurley, Quiksilver, and Vans. The company's sales clerks wear the gear and know their stuff cold. Zumiez, founded in 1978 by its chairman Thomas Campion (who owns 25% of the company's stock), plans to open about 40 stores in 2006. We believe Zumiez enjoys considerable brand loyalty among its shoppers and we would gladly invest even at today's lofty levels: Zumiez, which grew its earnings 61% over the last 12 months, currently trades hands at 1.0 x growth (on a PEG basis). Because the firm is debt free and in high growth mode, we'd pay a premium for shares. As for whether or not the market agrees with us, only time will tell -- the stock is already up 40% YTD and rival JCPenny recently encroached on ZUMZ's niche.

Staples: (SPLS) Staples is the Hercules of office supply retailing. It sells office products, furniture, computers, and other supplies through its chain of nearly 1,800 Staples and Staples Express stores in the US and Canada and about 20 other countries. (More than 1,500 of its superstores are located in North America.) Staples also provides document management and copying services through its retail chain. The company targets small businesses and home office professionals. Staples' North American retail operation, which accounts for more than half the company's revenue, continues to expand at an impressive pace. It added almost 100 new stores to its portfolio in 2005 and plans to open another 100 locations in the coming year. A large part of the company's growth has come from its catalog and direct sales business, which now accounts for 1/3 of sales. Staples also has its eyes set on Europe, where it runs 250 retail locations. We like Staples' expansion plans since they indicate that management has insulated itself from a saturated domestic market. Staples, which boast industry-leading pre-tax margins, as well as ROIC (EBIAT/total invested capital), is in terrific financial shape (EBIT covers interest expenses over 23 x) and sells at less than 19 x. We believe a pick-up in sales related to back to school supplies could modestly lift shares over the next quarter.

PSUN and HOTT 1-yr chart:

ZUMZ and SPLS 1-yr chart: