Thursday, April 8, 2010

Discovering HOTT and CATO

Readers of this blog were alerted to the value propositions of Cato Corp (CATO) and Hot Topic (HOTT) as recently as December. The article was entitled Retail Tunnel Vision. It was even rebroadcast on Seeking Alpha under the title 2 Retailers off Wall Street's Radar.

It went largely unread, but those who did read it were harsh in their criticism. One comment reads simply "Total nonsense." Another accuses me of being a shill, touting 2 companies in which I own shares. Hey, at least it was thoughtful, well-reasoned criticism, right?

Those who know me will attest that I'm far too cheap to risk money on a company I don't believe in while hoping a lone online article will boost the shares. Nobody listens, remember? I chose the Lonely Value name for a reason! In any case, I was shocked by the tone of the criticism and it's lack of substance.

As for the quality of the research, I'll let the results speak for themselves.

Hot Topic was trading at $5.50 in December when I wrote:
With 44 million shares outstanding, Hot Topic has a $242 million market value ($5.50 per share). The company boasts $91 million cash and no debt. And despite the negative news, Hot Topic is profitable (and has been for years). With nearly 40% of its market value in cash, Hot Topic isn't going anywhere. Here's hoping management uses some of this cash to reward shareholders via a dividend or share repurchase. In any case, the doom and gloom is premature.
Yesterday, the company did just that, announcing a $1 a share special dividend and a regular quarterly dividend of 7 cents. At HOTT's new price of $7.75 a share (up 41% since the article), that represents a 3.5% dividend yield. If you adjust for the $1 special dividend (which is payable as of April 19th), the ongoing yield is over 4%. Now that is NO NONSENSE.

Times are still tough for Hot Topic and it is fairly valued at current levels barring an improvement in its revenue line. Same-store sales trends have been ugly. Nonetheless, I'm holding my existing shares. The dividend and the debt-free balance sheet should limit any downside risk. Tread carefully if you are thinking about buying HOTT.

Either way, it is nice to see a management do the right thing with excess cash. This is a point also made in another excellent article posted recently called - Hot Topic: Suddenly the Highest Yielding Retail Stock.

Sentiment changes fast on Wall Street. Yesterday investors were uniformly negative on Hot Topic's prospects and its shares. I doubt any of them bothered to look at the company's balance sheet or cash flow statement.

The same is true of Cato Corp, the other retailer I mentioned in December. At the time, it was trading at $19 a share. Today it trades at $23.50, up 23%. Not bad for 4 months.

The corporate governance issues at CATO have been well documented in these pages. Dual share classes, excessive compensation, etc. But with all its warts, Cato remains a bargain. The company's value is less than $700 million, despite $200 million in cash, free cash flow between $40 and $50 million a year, and a healthy dividend yield of over 3 percent. The announcement today only adds to the allure. The company raised earnings guidance thanks to an increase in March sales of 24%. The top line has not been a problem for Cato.

With all these attributes, let's hope the Cato board wakes up and eliminates some (governance) issues the company does have. This will only enhance shareholder value.

As I said in the previous article...
Clearly, these are not "feel good" stocks. Don't expect validation from Wall Street analysts. No high-fives from your friends at the gym. Just lonely silence. Then again most great investments don't come with a choir of angels. Just ask Buffett about his Geico purchase. It pays to venture beyond the informal "approved" list.
If the news flow and returns for HOTT and CATO don't prove the point, nothing will.

Disclosure: Author continues to own CATO and HOTT.


  1. i always read your posts but i never comment, but i feel compelled to show you my gratitute for awesome posts!

    thanks lonely value investor!

  2. Hey thanks... that means a lot! Compliments are much appreciated... and so is constructive criticism. As you can see, I don't appreciate the "you suck" comments or the ones questioning my ethics. I love sharing investment ideas and debating the merits. If my articles have been helpful, I'm thrilled. Thanks again.

  3. I bought Hot Topic at $5.40 after your writeup and it's been a great stock to watch. Thanks!

  4. FYI: Cramer is now hot on HOTT.