Party City Holdco Inc.'s (PRTY, Financial) 57% decline over the past year could present a recovery opportunity for investors.
The party supplies retailer is making changes to its store estate, while its international growth plans could contribute to its successful financial turnaround.
International opportunities
The company’s sale of its Canadian retail assets in August to Canadian Tire could strengthen its financial outlook. Party City will utilize the proceeds from the transaction to reduce its leverage, which could improve its competitive position and reduce its overall risk from an investment perspective.
In addition, the deal includes a supply agreement between Party City’s manufacturing business, Amscan, and Canadian Tire. It has an initial term of 10 years and could benefit from Canadian Tires’ plans to double sales across Party City locations in Canada over the next two years. This appears to be a realistic goal since over 90% of the country's population is within a 15-minute drive of a Party City store.
The deal is similar to the franchise relationships that Party City has in Mexico, as well as its European and Australian retail agreements. It forms part of its international growth strategy, which could diversify its business and boost its growth rate.
Store changes
The company opened three new smaller format concept stores in the second quarter. They are between 7,000 and 10,000 square foot test stores that offer unique assortments of the company’s products in smaller markets that may not require one of its larger stores.
Party City’s smaller stores require 30% less inventory than its larger stores, but it expects them to deliver 90% of its larger stores’ sales, according to its second-quarter update. This should equate to an improved return on investment for the business, as well as more time for employees to interact with customers. This could improve the company’s customer conversion rates and boost its sales performance.
The company closed 34 U.S. stores in the first half of 2019 as part of its strategy to close underperforming locations, reporting that its sales recapture rates from customers of closed stores were in line with its expectations. This could mean additional store closures could have a positive impact on its bottom line.
Potential risks
Party City’s second-quarter sales and earnings figures were below its internal expectations. They were negatively impacted by a helium shortage across many of its markets, which caused the company’s comparative sales to decline 2.1% in the second quarter.
In addition, the business could be negatively impacted by ongoing trade tensions between the U.S. and China. Its total annual purchases from China are around $150 million and are subject to tariffs. This could lead to Party City increasing its prices or accepting lower margins over the medium term, which may hurt its financial outlook.
The company reported in its second-quarter results that it is making progress in procuring sufficient helium to satisfy customer demand. For example, it entered into an agreement that provides the business with 35% of its average monthly demand of helium.
In response to the threat of tariffs on imports from China, the business is developing its manufacturing capabilities in other countries. For example, during the quarter, it concluded the final shipment of products from a new joint venture with one of its suppliers in Cambodia. This may gradually reduce its dependence on China, though in its quarterly update the company said it estimates the potential impact on its bottom line from existing tariffs will be less than $2 million in the current fiscal year.
Outlook
Party City is forecasted to post a 16% increase in earnings per share next year. Since it trades with a forward price-earnings ratio of 5, its valuation suggests it has investment appeal.
Disclosure: The author has no positions in any stocks mentioned.
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