TAKING STOCK IN THE TEEN MARKET
TO FOLLOW TEEN RETAILERS, WALL STREET ANALYSTS IMMERSE THEMSELVES IN THE WORLD OF TEENS — FROM MALLS TO MTV
Byline: Catherine Curan
NEW YORK — At the Pomona Calif.-headquarters of teen retailer Hot Topic, MTV blares constantly from big screen TVs suspended from the ceiling, insuring that every employee, from the bookkeeper to the top merchant, understands the mind-set of the teens they sell to.
Likewise, analysts who follow publicly traded retailers such as Hot Topic, Gadzooks, Pacific Sunwear and catalog company Delia’s must spend time tuned in to music television, watching extreme sports and hanging out in the mall — just like teens do. That’s a different role for Wall Street, where executives are more accustomed to talking to chief financial officers than to teenagers, analyzing economic trends rather than reading Seventeen, and focusing on details of revolving credit facilities rather than what the hot deejays at the cool clubs are spinning.
The death of Merry-Go-Round Enterprises in 1996 and ailing fortunes of Edison Bros. and County Seat over the past five years have left many investors jumpy about junior apparel stocks. But analysts say investors are overcoming their hesitation because of the strong growth potential of the market. And some on Wall Street see these companies as the best investments available in apparel retailing today.
Robin Murchison, analyst at South Coast Capital, New Orleans, said: “I think investors have reached a level of understanding. The numbers talk to them, the demographic and the spending power.” Murchison follows Gadzooks, Delia’s and Claire’s.
Maria Medaris O’Shea, equity analyst at BT/Alex. Brown, Baltimore, asserted that investors who might have been burned by the fall of teen retailers in the early Nineties should recognize that now the economic and demographic scenario has changed for the better. The number of kids, their spending power and the fashion environment have all improved.
Different analysts split the demographics in various ways, some focusing on ages 10 to 24, and other on ages 12 to 19. But everyone agrees this population is growing. According to O’Shea, who focuses on kids aged 13 to 19, it is set to peak at over 30 million in 2009, compared with 26.6 million in 1997. This, says O’Shea, is twice the rate of growth of the overall population. And just as the population is surging, so too is the amount of discretionary income these kids have.
According to Chad Jacobs, an investment banker with BT/Alex. Brown, kids spent an estimated $36.7 billion, or 23 percent of their income, on jeans, shoes and sneakers, casual tops, dress clothes and other related soft goods in 1996.
Jacobs has been credited as the first on Wall Street to meld demographic and psychographic trend information to create a portfolio of teen stocks. In December 1994, while working as an equity analyst at Ladenburg, Thalmann & Co., he launched a group of such stocks, publishing a report called ‘Selling the MTVers.’ In the report, Jacobs discussed the marketing savvy and shopping habits of the kids he calls Generation 2000, which includes girls aged 10 to 22, with the core group aged 12 to 17.
BT Alex. Brown’s O’Shea has made teen retailers her specialty. She can nimbly switch from talk of teen trends to discussion of financial information. “To be successful following these companies, you have to know everything about the teen mind-set before the company’s fundamentals,” O’Shea asserted, adding: “I watch MTV every day.” Earlier this year, O’Shea cut her portfolio of stocks down to a core group of teen retailers, including Gadzooks, Pacific Sunwear, Hot Topic and accessories chain Claire’s. She dropped coverage of Talbots and Ann Taylor, among other women’s apparel retailers.
“In my opinion, [the teen group] is the best place to be in apparel retailing,” she said, adding: “The baby boomers are not spending on apparel.” To make the case, O’Shea cited recent lackluster results at Ann Taylor, Talbots and the Limited. Other analysts agree that teen stocks have performed better than apparel retailers as a whole.
Shelly Hale Young, branded consumer analyst at Hambrecht & Quist, San Francisco, said: “I would argue Delia’s is the fastest-growing consumer company on Wall Street,” citing sales growth of 245 percent and earnings growth of 312 percent in the second quarter ended Aug. 2. “The kinds of growth rates Delia’s is posting are the kinds you see from consumer software companies,” said Hale Young, adding: “But the multiple [price-earnings ratio] afforded Delia’s is significantly lower than technology stocks growing at the same rate.”
One teen retailer that has fallen out of favor with some on Wall Street is Wet Seal Inc., one of the largest in the business with sales last year of $374.9 million. Some analysts complained that Wet Seal did not provide them with the information they needed when they needed it and have dropped coverage.
However, Tom Tashjian, analyst at Montgomery Securities, San Francisco, rates the company a “buy.” Tashjian cited the firm’s new store concept, new catalog, growth in square footage and strong balance sheet, and he noted that compared to other teen retailers, Wet Seal has a low share price.
Ann Cadier Kim, chief financial officer of Wet Seal, said she believes the company has strong relationships with analysts and makes itself available. “Whenever they have questions they are always free to call,” she said, but added: “I don’t think we’re too unlike other companies that want to dedicate themselves to running the business.” O’Shea said it definitely takes a different mind-set to follow teen stocks as opposed to more traditional specialty retailers, such as Ann Taylor.
“It’s easier for most retail analysts because they are Ann Taylor’s customer. The challenge is to put yourself in teens’ shoes and see how they will react to different influences,” she said.
“You’re constantly trying to think like a teen and the only way to do that is to surround yourself with teens.”
To get into the minds of teens, O’Shea also reads all the magazines that appeal to teens, including Rolling Stone and Spin, not just fashion magazines.
At age 26, analyst James Palczynski, of Ladenburg Thalmann, said he feels close enough to the teen group to understand it, adding that he has the benefit of insight from younger siblings and teenaged friends.
Other teen immersion tactics include spending time talking to skateboarders in Greenwich Village and attending sports events like the X-Games in San Diego. “You really can’t underestimate the influence this has had on fashion,” he said. “The bright colors we see now were worn by rock climbers years ago.”
After Jacobs left Ladenburg in March, Palczynski took over coverage of the teen stocks and dropped some sporting goods companies such as Veriflex and Oshman’s to refocus on the apparel firms, which he believes are the strongest companies. His current group includes Pacific Sunwear, Hot Topic and Delia’s.
“Wall Street views this consumer as inscrutable,” Palczynski said. “Your average portfolio manager doesn’t understand his own kids, much less kids in general, and therefore he views these stocks as somewhat inscrutable.”
Another unusual aspect of covering teen stocks is the interaction analysts have with management. “The more commodity-driven a product, the more you can rely on a chief financial officer,” said South Coast Capital’s Murchison. “In companies where the product is creative, you rely on the merchandisers a lot.”
Alice Ruth, analyst at Montgomery Securities, said most of the management teams for these companies started when the companies were very young, so the executives are very close to their customer base and operate close-knit organizations. “That makes them interesting and more fun than some of the other management teams with a more-corporate corporate culture,” said Ruth.
Palczynski said that the nuts-and-bolts analysis is the same with teen stocks as it is for retailers in general, but added: “When you pick stocks in a teen industry, I think what you have to look for is a management team that truly understands the core customer.” An executive at one teen retailer, who declined to speak for attribution, said analysts look for management that not only understands the teen mind-set but can manage rapid growth.
Asked if there is a showdown brewing between department stores and teen retailers for the teen customer, analysts said they think teens will prefer to shop in stores created especially for them. Kids are encouraged to hang out in these stores, which is not always the case in department stores. “Kids have probably been thrown out of stores since there have been stores and kids,” said Ladenburg’s Palczynski.
Analysts said the number of people following junior stocks remains small not because of a bias against teens, but rather because of the small capitalization of these companies. They insist these stocks are not much more volatile than other specialty retailers.
So what are the rewards of overdosing on malls and MTV?
O’Shea said a lot of these stocks are priced to perform and are punished severely when they disappoint. O’Shea said it’s painful when things go wrong, but said on the whole covering these stocks is “invigorating and exciting. It’s fun to get into the mind-set of the teens.”
Added South Coast Capital’s Murchison, “This group is worthwhile because it moves,” noting that any sort of movement, whether up or down, can make covering the stock worthwhile for an analyst “as long as you know which way it’s going to go.”