Most of specialty retail sold off today after many retailers reported January comp-store sales results and others reported 4Q sales results and updated guidance. While Hot Topic (NASDAQ:HOTT) wasn't the biggest surprise of the day, HOTT's results do seem to have gone un-noticed or under-appreciated by many investors. (Incidentally, I would say was KSS was the biggest surprise of the day--reporting a January comp of +13.3%, well above expectations, but trading down as much as 1.5% mid-day).
With HOTT, I think there are a few reasons they should pay attention.
Leverage on In-Line Comps Validates Gross Margin Focus. First, HOTT's 4Q comps rose 2.6% vs. 1.9% LY, in-line with management's expectations for a low-single-digit to mid-single-digit increase in comps, but the company raised its 4Q EPS guidance to $0.26-$0.27 per share from its prior range of $0.23-$0.27 and vs. $0.21 LY. This amount of earnings leverage on an in-line comp implies that HOTT's recent significant improvements in full-price selling and gross margin rates continued throughout 4Q, further validating CEO Lisa Harper's strategies to bring consistency to the Hot Topic division's results (eliminating the boom-and-bust cycle the division used to experience around blockbuster movie and album launches) and to re-engineer the Torrid concept as a vertically-integrated retailer focused on strip-malls (rather than enclosed regional malls). While Harper has made solid progress on both these strategies in both divisions, there's still a long way to go.
In-Line Comps Despite Headwinds. Secondly, these comp results are strong given some headwinds that both divisions probably faced throughout the quarter. At Hot Topic, the large tee and hoodies business is still being normalized--as part of Harper's strategy to reduce the prior boom-and-bust nature of this category (remember Twilight....and so many others?) and the accessories category continues to face general weakness with progress from -10% comps in 3Q hopefully in the works some-time during 1H-13. And at least a significant portion of Torrid's -1.9% comp probably reflects weakness in the e-commerce channel, where the division significantly reduced clearance sales on the web-site (a net benefit to gross margins) but then also overly-severely restricted e-commerce SKU counts to drive productivity (a good idea just taken too far). With these headwinds in 4Q and progress on merchandising initiatives in both divisions, I think comps can accelerate throughout FY13 even with more difficult comparisons in the first half.
Still A Lot of Improvements to be Made. Finally, there's still a tremendous amount of low-hanging fruit at HOTT ranging from the company's relatively new and unsophisticated CRM initiatives to the ability to drive efficiencies in distribution practices from warehouses to stores. With the transition to the vertically-integrated strategy at Torrid completed in 2H-12, I expect we'll hear much more about strategies to block and tackle these type of opportunities from the company throughout 2013.
I know that HOTT shares look expensive on a P/E basis relative to the teen specialty retail group--trading at 26x FY12 EPS estimates (vs. the group's 14.5x multiple) and 21x FY13 EPS estimates (vs. the group's 20x multiple), but I would argue that HOTT has both EBIT margin expansion potential and square footage expansion potential--two factors many of their competing teen specialty retailers don't have. (Specifically, I think Torrid is a viable store growth story after it's repositioning and I think EBIT margins at HOTT will end FY12 at 4.1%, down from their peak of 13.3% in FY03, and well below the peer group average of 9.7%.) As HOTT continues to execute on its turnaround throughout FY13, I think we'll see more investors realize the possibilities of the new HOTT growth story and more upside to the shares.
Disclosure: I am long HOTT.