Summary
- Party City at 2x FY2021 operating income and $200 million market cap is priced like future bankruptcy is likely.
- Party City has a confluence of factors that makes it compelling as a trade, especially Halloween being soon.
- After Bed Bath & Beyond, Revlon and Redbox, Party City is well-poised to be a next big retail trade.
- As a fundamental investment, Party City could be a melting ice cube or quality business and still bring large returns from current levels.
- The fundamental thesis provides margin of safety for a near-term trade and target of 50% upside.
Overview
Party City (PRTY) is the largest integrated party supplies and party costumes producer, wholesaler, and retailer. It has a market cap of a paltry $201 million at last Friday’s close, whilst having $2.171 billion in revenue in FY 31 December 2021, giving it a Price/FY 2021 revenue ratio of 0.092x. Being priced as though it has an impending liquidation is the result of its sizeable debt load. Party City has net debt of $2.33 billion, giving it an EV/FY2021 revenue of 1.07x. Party City made a net loss of $6.5 million in FY 31 December 2021, with interest costs of its high debt load eroding away operating profit. Operating income was $96.9 million in FY 31 December 2021, and thus at its current market cap, the stock trades at 2.07x its FY 2021 operating income.
Thus, the stock has the Ben Graham classic value romanticism of having a deep value appearance, maximum market pessimism reflected in the stock price, plus has an asset (its wholesale business Amscan) within the company that could be a high-quality business. The business could be stagnant and with a high debt load but it is priced similar to companies already in bankruptcy.
Potentially too, Party City could become a high-quality Phil Fisher style business play rather than a Graham style deep value play on a mediocre business. Fundamental bulls on the stock have a contrarian view that the company is a quality business on the brink of a revenue turnaround, with a fair value of $30 being attainable in the long run. We should also note that Party City’s largest shareholder, hedge fund CAS Investment Partners added to its holdings at above $6 earlier this year.
So, there are two bull case scenarios for Party City as a long-term fundamental investment. The first, that it could be a cheaply priced melting ice cube or a cigar butt that’s due for its last fulfilling puff. Or it could be a long-term quality business compounder in the turnaround scenario. Either could bring tremendous long-term upside from the sub $2 levels that the stock has been lingering around.
The fundamental bull cases for Party City are of relevance to me, but not in making a long-term fundamental investment in the stock. I view Party City to be most interesting as a near-term trade for a significant potential return in the lead up to Halloween. That there is a good fundamental bull-case is of relevance for the margin of safety in my trade, as the fundamental investment thesis is helpful for near-term trading sentiment and that a potential near-term price floor has been reached.
Indications are that this Halloween season is looking strong for Party City, with its announcing plans for 20,000 hires for the season (versus 17,000 last year). Recent weeks' trading volume in Party City has been significantly elevated versus average, with the stock generating significant retail interest and Reddit and social media mentions. In recent months, other small cap, struggling retail names Bed Bath & Beyond ( BBBY ), Revlon ( REV ) and Redbox, have seen temporary price surges multi-fold higher from their lows. Although we have seen a recent significant sell-off in the market, we should note that the surges in Revlon and Redbox took place during the market’s bear period. Party City has a concentration of shareholding held amongst its largest shareholders and an elevated short interest (18% of float). With its paltry market cap due to its debt load, it will not take a lot of positive news flow for Party City stock to see a big move higher.
There are also two pieces of news flow which give Party City stock an all-clear to have an upward surge in the lead up to Halloween. Latest quarterly results were fair, with an earnings beat and revenue almost in-line. Meanwhile, a lingering concern that its largest shareholder – CAS Investment Partners - might need to sell its stake amidst the fund’s decline this year should have lifted amidst a rebound in its top positions.
Party City has reached the high $2.60 levels on two occasions in recent weeks before retracing back to its current sub $2 levels. I view that the combination of the above factors in the nearer term should see Party City head back to the high $2 levels again before it breaks $3. Therein, there is the potential for more than 50% near-term upside in my view, depending on where one enters Party City stock, amidst its sub $2 dips.
Whilst for the purpose of my trade, I will be exploring the bullish case for Party City as a longer-term fundamental investment, I do not have high conviction yet whether the longer-term case will play out. Rather, I am very bullish on Party City as a near-term trade. For this reason, if the trade thesis does not appear to be playing out, I am prepared to fold and trade quickly and revisit the stock again.
Party City
Per annual report , Party City describes itself:
“we are a leading party goods company by revenue in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally by revenue...Party City has grown to become what we believe is the largest operator of owned and franchised party superstores by revenue in the United States.
Party City’s fully integrated operations today are the result of the original Party City retailer being acquired in 2005 by the parent company of Amscan, a designer, manufacturer and distributor of party goods. Subsequent acquisitions of other party goods retailers followed which ultimately brought Party City to be the industry’s largest integrated player. Party City had various private equity owners in the early 2010s before an IPO in 2015 when it debuted at $17. Debt levels have always been high.
Party City’s declining revenue and margins prior to the pandemic were the result of a variety of factors. Competition from Amazon (AMZN) and Big Box retailers, a helium shortage and poor layout and merchandising execution in their stores are some factors. Issues of competition and the helium shortage persist presently.
Party City’s current CEO Brad Weston was appointed to the role in April 2020. The company has since embarked on a variety of strategic initiatives, notably enhancing the in-store experience through remodeling or opening new stores dubbed “ NXTGEN stores ”. Given the pandemic’s impact on celebrations and the supply-chain, it has yet to be determined how successful is the new CEO’s turnaround and execution versus his predecessor. But there is some reason to be optimistic, given Weston’s previous background as CEO of Petco. There are also similarities of Party City with Petco, Petco being a private equity controlled highly leveraged retail business which turned around from struggling operating performance and gradually reduced debt.
As shown below, Party City’s debt levels have always been high, although it has had higher debt levels in the past compared to those presently. Besides, Party City does not face any major debt repayment soon. It has a senior note due in 2023 with a carrying amount of $22.779 million which is not sizeable, whilst its next major debt repayment is due in 2025 ($206 million).
Source: Annual report
Next, let’s look at Party City’s financials. Operating income in FY2021 was $96.9 million and the company had a net loss of $6.5 million as interest costs eroded income. The company recorded a large net loss in FY2020 due to the pandemic. In FY2019, Party City suffered a decline in revenue and significant decline in operating margins and operating income. Its FY2019 major net loss was the result of extraordinary items, primarily goodwill impairment.
Source: Seeking Alpha
Party City as a classic value cigar butt
Party City trades at 2.07x its FY2021 operating income presently and its FY2021 operating income was the lowest in the past decade except for 2020’s pandemic onset year. On this basis, Party City appears dirt cheap – the classic value style cigar butt or melting ice cube. Since 2019, revenues have declined, operating margin has plummeted and most of operating profit is gone to servicing debt, hence the low valuation multiple. But nearer term debt is manageable and there is enough time for signs of operational improvements and performance to be demonstrated by management. Furthermore, Party City’s steady revenue during its 2012-2018 period, indicates that its pre-pandemic stumbles are due mostly to operational decisions rather than the headwind of Amazon, e-commerce and Big Box domination. If Party City's revenue and operating income can recover to pre-pandemic levels, its current valuation multiple becomes even cheaper.
Party City as a quality business
Note that between FY2012 to FY2018, Party City saw a consistent and steady rise in revenue. Its stock price reached above the $16-17 levels in 2016 and 2017. It does not appear to have been impacted by Amazon or Big Box retailers to the same extent as other specialty retail peers during this period. Indeed, thinking about the case for consumers to visit Party City does bring to mind several strengths that party goods specialty retail could have. Helium balloons are highly difficult to be sold online. Parties are special occasions and irregular events - it makes sense that shoppers of party goods (who only buy party goods or costumes irregularly) would prefer to buy in person where they can ensure the items are suitable for the special event. Going to a party goods specialty store seems a logical choice for consumers and Party City’s fully integrated operations and specialized expertise should be an advantage, if their retail stores are well-executed.
One of the bull case arguments for Party City is the value of its wholesale Amscan business itself, which is obscured by the accounting booking of Amscan sales to Party City retail under its retail segment. Per annual report, in FY2021, 81.5% ($1.76 billion) of its total revenues came from retail and 18.5% ($401 million) from wholesale. However, Amscan’s sales to Party City’s retail business are booked under its retail segment due to accounting rules. Per annual report, in FY2021 “81.1% (equivalent to $1.427 billion) of the product that was sold by our retail segment was supplied by our wholesale segment and 26.7% ($381 million) of the product that was sold by our retail segment was self-manufactured.” Hypothetically, Amscan wholesale has $1.828 billion in revenue if its retail sales to Party City are included. That is an impressive figure for the wholesale business. However, Party City’s retail business and its wholesale business are intertwined, and the performance and stand-alone value of Amscan would presumably be lower if it were not part of Party City.
Ultimately, the competitive advantages that Party City has via Amscan, specialized expertise and its fully integrated operation will have to be demonstrated through its financial performance. With its high debt load, there is not much room for long-term error for Party City, but it likely has some breathing space to demonstrate improvements until its larger debt obligations come closer. After the pandemic’s impact, the pre-pandemic’s missteps in operations, and a helium shortage somewhat out of its control, the rest of year results are an opportunity for the company’s relatively new CEO to demonstrate the fruits of his turnaround measures. Even small, consistent positives in operational results would likely to bring a virtuous cycle to the stock price, as it would back the bull case and contrarian view that there is a quality business here that can see steady long-term revenue growth.
Risk Factors
Stocks with dirt cheap valuation multiples are priced like so for a host of issues they face. Party City has a high debt load, declining revenue and margins, competition from Big Box retailers and Amazon and a previous operational strategy that requires its current turnaround. The company’s turnaround has yet to demonstrate its success yet. There is a lot to not like. There are headwinds out of the company’s control such as the example of the Omicron strain last year and new future strains that may emerge. The helium shortage has also been a long-term issue for the company. Thus, the fundamental thesis that provides margin of safety for a trade or investment faces many potential hurdles. As a trade, the stock price has attempted to go above the $2.70 levels on two occasions in recent weeks before it retraced back to sub $2 levels. It is unclear whether there is enough catalyst for the stock price to breach my $3 price target within the lead-up to Halloween. Any negative news on Halloween consumer trends, retail peer performance or company updates may sour the Halloween trade thesis. Further, the continuing market sell-off is not conducive for Party City stock and it cannot be expected to defy a negative broader market trend. Although Party City stock has seen a precipitous decline this year, it has seen much lower price levels during its 2020 lows.
Conclusion
Party City has a set-up to be very bullish on the stock for a near-term trade. Sentiment in the lead-up to Halloween is a catalyst, as are a confluence of positive trends in the stock tape, retail interest and social media mentions, small market cap, elevated short interest and the appearance of a dirt-cheap looking valuation multiple. The fundamental investment bull case also provides a potential near-term price floor for the trade. I view the stock as a near-term trade for outsized upside. It will remain on my radar as a potential fundamental long-term investment, although it looks compelling for trading (as opposed to buy and hold) on a longer term basis too.
For further details see:
Party City Stock: It's Party Time