Stock Mart: Topps

Just don't call it a Pokemon stock.

In its most recent second quarter, collectible-card and candy company Topps (TOPP) got just 18% of sales from the division that includes its new line of Pokemon trading cards. And its shares, which closed Friday at 8 and trades at just 11 times predicted fiscal 2000 earnings of about 72 cents a share, would be a bargain even without the monster connection, say analysts and investors.

"I got into it as an earnings story and a turnaround story, not a Pokemon story," says Tim Gray, an analyst with Fechtor Detwiler & Co. who initiated coverage with a buy on Sept. 23. (His firm hasn't underwritten for Topps.)

Until recently, Topps, whose shares have fallen from a high of almost 11 in August but are still up some 56% this year (according to data-tracker Baseline), definitely looked in need of a turnaround. In fiscal 1999, which ended Feb. 27, sales fell 5%, following a 10% drop in the previous year. Sales of collectible sports cards have been soft for much of the decade, a decline exacerbated by the 1994 baseball strike and last year's basketball lockout. And Topps made its own missteps, including its 1998 choice not to offer NHL cards. (It's since reversed course.)

A Turnaround for Topps Its share price has fallen from its August high, but it's still up some 56% this year.

Source: BigCharts

But while the sports-card business still isn't exactly hot -- Topps' sales rose 8% in the second quarter, largely due to favorable timing of shipments -- the segment is no longer declining. "There's been somewhat of a shakeout, and the market has rationalized itself," says Brad Evans, an analyst with Heartland Funds, which owns 697,000 Topps shares. "The issues that plagued the industry seem to have passed." And with its strong distribution network, and place as a lead player in the category along with Upper Deck and Fleer, Topps is well positioned to take advantage of the market's recovery, he says.

Topps is also looking to capitalize on its strong card brand by -- you guessed it -- using the Internet. Chairman and CEO Arthur Shorin says details of Topps' strategy won't be announced until toward the end of the fiscal year, but that it would likely extend beyond merely shopping for cards online. Analyst Gray speculates that the plan might include in-house card auctions. Thursday Topps said it elected Ann Kirschner, president and CEO of Morningside Ventures, which develops online education services for Columbia University, to its board.

Topps' candy business -- home to the eyepatch-wearing icon Bazooka Joe -- generated 45% of sales during the second quarter and is growing like gangbusters. Candy sales rocketed 28% in the second quarter thanks to its new Baby Bottle Pop and older products like the Ring Pop and Push Pop. Competitors Tootsie Roll (TR) and Wrigley (WWY) trade at about 3 times revenue, notes Evans. Applying the same multiple to Topps' fiscal 1999 candy revenue gives a price of about 6 -- even before its other units' contributions are added in.

While the candy sector is competitive, Topps has the chance to capitalize on some of its strong brand names through better marketing -- the unit could grow between 15% and 25% annually, says John Taylor, an analyst with Arcadia Investment Research in Portland, Ore., who rates Topps a buy. (His firm doesn't do underwriting.) And sticking with its pop theme, Topps is launching a Pokemon pop in November.

Ah yes, Pokemon. Topps has its own line of collectible trading cards, aimed at a slightly younger audience than Hasbro's(HAS) Wizards of the Coast line, which contributed about $7 million in sales and 5 cents of per-share earnings in the second quarter. In a recent research note accompanying her downgrade of Hasbro, Salomon Smith Barney analyst Jill Krutick said the Topps line may steal sales from Hasbro's own lineup. (Krutick doesn't follow Topps.)

"They're getting in somewhat late to the U.S. market, but the cards are selling out everywhere," says Taylor. And peres and meres, beware: Pokemon is gearing up to hit Europe. "The anticipation is huge," says Taylor. "Up until now they've only had gray-market goods." The entertainment division, which includes Pokemon as well as Star Wars and Marvel Super Hero Universe characters, had more than $14 million in sales during the second quarter, an increase of nearly sevenfold from the same quarter a year ago. "They'll continue to build that out, and at some point they'll think of it a core business," says Taylor.

Topps has also cut costs galore -- in part by closing plants and contracting out most of its manufacturing -- and improved margins, which, along with reduced royalty payments, helped it swing to earnings of 34 cents per share in fiscal 1999 from a loss of 10 cents per share in fiscal 1998. Gray, of Fechter Detwiler & Co., is looking for Topps to show sales growth of about 38% this year and to earn 72 cents per share and 90 cents in fiscal 2001 -- a projected earnings jump of 25%.

The company's balance sheet is in good shape: Long-term debt fell to about $5 million last year from $22 million a year earlier, and Topps generated about $30 million in cash from operations last year. Insiders have been buying recently, and Topps recently announced a buyback plan. At its current stock price, analysts don't see much downside. In addition to its low P/E, Topps has a price-to-sales ratio of 1.29 and a price-to-book ratio of 3.8.

Fiscal 1999 "was the story of cost-cutting and streamlining, and in 2000 they're focused on growth," says Heartland Funds' Evans. Sure, part of that is hooked to the Pokemon craze, he says. But there's enough going on at Topps to make it a bargain even if Pokemon becomes passe.

And perhaps Bazooka Joe cards will be the next hot thing.

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