Party City Stock: The Balloon Popped (NYSE: PRTY)

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A year ago I wrote a “sell” article on Party City Holdco Inc. (NYSE: PRTY), and since then the stock has fallen 85%. My previous thesis was that even though Party City’s prospects had improved, the business continued faces significant debt, potential helium shortages and fierce competition. Add to that the new pressures associated with the current economic environment – the risks of inflation and recession – and it’s easy to see why there has been a significant revaluation of the stock.

Party City stock price vs. last year

Party City Stock Price (Seeking Alpha)

Some investors may now view Party City as a “deep value” turnaround opportunity at these levels, as the company continues to anticipate sales of $2.22-2.3 billion for the year, making the current market capitalization seems tiny. However, Party City’s high debt load, combined with the prospect of rising costs and further demand destruction, leaves the stock with plenty of room to fall.

Latest results

Shares of Party City fell below $2 for the first time in more than a year in May as the company announced its First quarter results. The quarter highlighted the impact of freight and raw material cost increases on Party City’s results. Revenue increased 1.4% to $433 million while net loss was $26.9 million from $14.1 million in 2021. A decline of 380 basis points from gross margin at 31.9% represents a significant deterioration in profitability and highlights the impact of inflation and shipping costs on input prices. Party City is also under pressure with its operating expenses, which have jumped from $9 million to $158 million. This is due to higher labor costs – likely due to wage inflation.

As margins deteriorate and costs soar, the company actually expanded its YOY ​​store count by eight stores. Although small, I think it’s a step in the wrong direction and will hamper shareholder value. Party City should really downsize and look to focus on its most valuable locations. This action, or lack thereof, backfired on the business as input costs soared and losses began to mount. This issue is reflected in the forecast, with management expecting between $30 million and $48 million in net profit for the year.

Inventory spikes as input costs prove troublesome

Cash flow used in operating activities also jumped to $116 million from $48.8 million last year, almost all of which can be attributed to higher inventory. Inventory value is now the highest since the pre-COVID period, due to higher input costs. CFO Todd Vogensen discussed this on the conference call:

Inventory increased approximately 21% year over year, primarily due to higher input costs including capitalized freight, higher levels of inventory in transit due to delays supply chain improvements, as well as initiatives to improve inventory positions.

This change in inventory is symbolic of the margin squeeze that Party City is currently experiencing. The company really needs to find a way to convey this to consumers, but trying to do so while dealing with a consumer crunch will prove very difficult. The CFO was quick to point out that this increase was not the result of a unit increase, only the cost of each unit, so Party City doesn’t mismanage inventory as such. Even problems that are somewhat beyond management’s control are still difficulties that will prove difficult to solve.

Party City will continue to monitor and adjust prices upwards throughout the year – particularly in the second half, but I think their hands are somewhat tied due to the implications this has on demand. Brad Weston (CEO) commented on the importance of monitoring demand:

We have taken a very consistent approach with any pricing action, testing, reacting, monitoring our elasticity at the category level and at the SKU level

Party City has stronger pricing power around Halloween, so the biggest price increase for wholesale and retail will most likely occur around this time.

Helium shortages worsen an already bad situation

The headwind that Party City has had to deal with when it comes to helium shortages has been a major driver of its value destruction in 2018 and 2019. Browsing through Seeking Alpha’s articles, you’re likely to find many authors discussing the issue. Unfortunately for the company this is a problem that will not go away and the board expects to pay higher prices for the remainder of 2022. The helium shortage has negatively impacted the gross margin of the first quarter of 320 basis points ($14 million).

Management faced further and warranted analyst drilling on the helium front during the conference call’s Question Time. I will note that Party City is indeed in a much better position than when it faced the shortage in 2018 and 2019, where the company got 90% of the helium from a single supplier. This situation is certainly not as bad as then, but it literally compares to a shortage crisis for the company. This is another hurdle on what becomes a long list for the retailer and wholesaler.

Bull case

Time plays into Party City’s hands at current prices. With debt maturing in 2025/26 after the restructuring completed in 2020, the company has time to get its finances back on track before this roadblock approaches. It is also fair to say that from current prices, if management were successful in effecting a turnaround, the upside from current levels would be significant. Party City’s 2000+% surge from COVID lows to June highs showed that the stock can quickly reprice if conditions improve.

Nevertheless, it must also be considered that the big race took place under much more accommodating conditions. Quantitative easing massively benefited Party City’s stock price as money flowed into stocks as stimulus checks boosted underlying activity. It’s easy to forget that at the start of the pandemic, the majority of the market thought Party City was headed for bankruptcy and those days could very well return. The restructuring was very clever by the management and saved time. Now, unless they can steer the ship again, they could start to approach those 20-cent lows again.

Conclusion

Party City is under pressure from all sides at the moment and despite management’s cautious optimism that much of the problems are temporary, at the very least the near future for the company remains very bleak. I believe that due to the continued pressures they face, Party City will have more short-term downside – sell.