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

Balloon attacked by hand with needle

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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 tumbled 85%. My previous thesis was that although Party City’s prospects had improved, the company still faced a large debt load, continued potential helium shortages, and fierce competition. Add to this new pressures related to the current economic environment – inflation and recession risks – and it’s easy to see why there has been a significant re-price in the stock.

Party City Stock Price over 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 cap appear minute. However, Party City’s significant debt load combined with the prospects of rising costs and further demand destruction leaves the stock with plenty further room to fall.

Latest results

Party City’s stock dropped below $2 for the first time in over a year in May as the company announced its First Quarter results. The quarter highlighted the impact freight and commodity cost surges are having on Party City’s bottom line. Revenue notched 1.4% higher to $433 million while net loss came to $26.9 million, compared to $14.1 million in 2021. A 380 basis point decline in Gross Margin to 31.9% represents a significant deterioration of profitability and highlights the impact of inflation and shipping costs on input prices. Party City is also getting squeezed on its operating expenses, which surged by $9 million to $158 million. This was driven by higher labor costs – most likely a result of wage inflation.

As margins worsen and costs soar, the company actually expanded its store count YOY by eight stores. Whilst small, I believe this is a move in the wrong direction and will hinder shareholder value. Party City should really be downsizing and looking to focus on its most valuable locations. This action, or lack of, has come back to bite the company as input costs have soared and losses have started to widen. This issue is reflected in the guidance, with management projecting between $30 and $48 million in net income for the FY.

Inventory spikes as input costs prove troublesome

Cash flow used in operating activities also surged to $116M from $48.8M last year, pretty much all of this can be attributed to increased inventory. Inventory value is now the highest it’s been since Pre-COVID driven by higher input costs. CFO Todd Vogensen discussed this on the conference call:

Inventory was up approximately 21% year-over-year, driven primarily by increased input costs, including capitalized freight expense, higher levels of in-transit inventory due to ongoing supply chain delays, as well as initiatives to improve in-stock positions.

This change in inventory is symbolic of the margin squeeze that Party City is currently feeling. The company really needs to find a way of forwarding this on to consumers but trying to do this whilst facing consumer tightening will prove very difficult. The CFO was quick to point out this increase wasn’t a result of unit increase just the cost of each unit, so Party City isn’t mismanaging inventory as such. Even issues that are somewhat out of management control are still difficulties that will prove hard to resolve.

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

We’ve been taking a very consistent approach with any pricing action, testing, reacting, watching our elasticity at the category level and at the SKU level

Party City has stronger pricing power around Halloween so the greatest price increase for both wholesale and retail will most likely come around that time.

Helium shortages worsen an already bad situation

The headwind Party City has faced in relation to helium shortages was one of the greatest drivers behind its value destruction in 2018 and 2019. Scouring through Seeking Alpha articles, you are likely to find many authors discussing the issue. Sadly, for the company, it’s an issue that just won’t go away and the board expects to pay higher prices for the remainder of 2022. The helium shortage negatively impacted Q1 gross margin by a whopping 320 basis points ($14 million).

Management faced a subsequent and justified drilling from analysts on the helium front in the conference call question time. I will note that Party City is indeed in a far better position than when they faced the shortage in 2018 and 2019, where the company obtained 90% of helium from one supplier. This situation is certainly not as bad as then but that is drawing comparisons to quite literally a crisis shortage for the company. This is another obstacle on what is becoming a long list for the retail and wholesaler.

Bull case

Time plays into Party City’s hands at current prices. With debts maturing in 2025/26 after the restructuring achieved in 2020, The company has time to get financials back on track before this roadblock approaches. It is also fair to say that from current prices, if management were to successfully execute a turnaround, the upside from current levels would be large. Party City’s 2000+% runup from COVID lows to June highs showed that the stock can quickly re-price if conditions improve.

Nonetheless, it also must be considered that the large run-up came under far more accommodating conditions. Quantitative easing massively benefited both Party City’s share price as money flooded into equities while stimulus cheques boosted the underlying business. It’s easy to forget that at the onset of the pandemic, the majority of the market thought that Party City was heading for bankruptcy and those days could very well return. The restructuring was very shrewd by management and bought time. Now, unless they can steer the ship around once again, they may start to head near those lows of 20 cents again.

Conclusion

Party City is getting squeezed from all directions at the moment and despite management’s cautious optimism that much of the troubles are temporary, at very least the near future for the company remains very dim. I believe that due to the continued pressures they face, Party City will have more near-term downside ahead – sell.

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