Please ensure Javascript is enabled for purposes of website accessibility

Foolish Forecast: Is It HOTT in Here?

By Rich Smith – Updated Nov 15, 2016 at 5:50PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Views you can use to get clues on tomorrow's news.

What's in a name? Sometimes, very little. Other times, a lot. When supposedly hip clothier Hot Topic (NASDAQ:HOTT) reports Q4 and full-year 2005 earnings tomorrow, expect it to be one of the "little" days.

Wall Street Wisdom:

  • General consensus. For all of its troubles, Hot Topic is still the popular kid in class. Twenty analysts follow it around, and although 12 of them rate the stock a hold, eight still call it a buy.
  • Revenues. Quarterly sales are expected to climb 8% to $228.8 million.
  • Earnings. Meanwhile, profits are following the stock price downward. (Or is it the other way around?) The Street expects a 42% decline in earnings to $0.22 per share tomorrow.

Margin watch:
Here's why. Just because a company's selling more stuff doesn't necessarily mean it's making more money. In fact, if the company's margins deteriorate, selling more stuff can result in making less money. That's precisely Hot Topic's problem. Rolling gross margins have declined by 350 basis points over the past 18 months, and that amount was subtracted penny for penny from bottom-line profits. As a result, Hot Topic is barely half as profitable today as it was just a year and a half ago.

Margins %

7/04

10/04

1/05

4/05

7/05

10/05

Gross

37.6

36.7

35.6

35.5

34.8

34.1

Op.

12.1

11

9.7

9.3

8.3

6.6

Net

7.6

6.9

6

5.8

5.2

4.1

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

Foolish lookout:
Mind you, Hot Topic could still "beat estimates." Analyst predictions for $0.22 in profits fall toward the low end of the $0.21-to-$0.24 range that the company posited just last month. Moreover, Hot Topic already announced Q4 sales that, at $230.6 million, exceeded the analysts' estimates.

But even if HOTT did do less horribly than analysts suspect, that's little reason to celebrate. The company is clearly in the midst of a long-term slide in profitability -- and not just accounting profitability (with profits down 47% year-to-date versus this time last year), but cash profitability as well. Inventories are rising much faster than sales -- 17% versus 12% in Q2; 22% versus 7% in Q3. As a result, the company was heading into Q4 in a much weaker position, free cash flow-wise, this year than last, with free cash outflows increasing 77% year over year.

The moral of the story: Forget the GAAP earnings tomorrow. We already know they'll be lousy -- it's only a matter of degree. Focus rather on inventories and free cash flow. That's where you'll find the first evidence of a turnaround, if one exists to be found.

Fool contributorRich Smithhas no interest, short or long, in Hot Topic.

None

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.