PRTY has traded down since it went public.
But I think investors are missing obvious catalysts for higher profitability next year.
At just 13.5 times forward earnings, the stock is very cheap.
(click to enlarge)
To do this I'll use a DCF-type model you can read more about here. The model uses several inputs including earnings estimates, which I've borrowed fromYahoo!, dividends, which I've set to zero forever, and a discount rate, which I've set at the 5 year Treasury rate plus a risk premium of 7%.
2015
|
2016
|
2017
|
2018
|
2019
|
2020
| ||
Earnings Forecast
| |||||||
Prior Year earnings per share
|
$1.04
|
$1.29
|
$1.49
|
$1.73
|
$2.01
| ||
x(1+Forecasted earnings growth)
|
24.00%
|
15.90%
|
15.90%
|
15.90%
|
15.90%
| ||
=Forecasted earnings per share
|
$1.04
|
$1.29
|
$1.49
|
$1.73
|
$2.01
|
$2.33
| |
Equity Book Value Forecasts
| |||||||
Equity book value at beginning of year
|
$7.41
|
$8.45
|
$9.74
|
$11.23
|
$12.97
|
$14.97
| |
Earnings per share
|
$1.04
|
$1.29
|
$1.49
|
$1.73
|
$2.01
|
$2.33
| |
-Dividends per share
|
$0.00
|
$0.00
|
$0.00
|
$0.00
|
$0.00
|
$0.00
| |
Book value end of year
|
$7.41
|
$8.45
|
$9.74
|
$11.23
|
$12.97
|
$14.97
|
$17.30
|
Abnormal earnings
| |||||||
Equity book value at begin of year
|
$7.41
|
$8.45
|
$9.74
|
$11.23
|
$12.97
|
$14.97
| |
x Equity cost of capital
|
8.45%
|
8.45%
|
8.45%
|
8.45%
|
8.45%
|
8.45%
|
8.45%
|
=Normal earnings
|
$0.63
|
$0.71
|
$0.82
|
$0.95
|
$1.10
|
$1.27
| |
Forecasted EPS
|
$1.04
|
$1.29
|
$1.49
|
$1.73
|
$2.01
|
$2.33
| |
-Normal earnings
|
$0.63
|
$0.71
|
$0.82
|
$0.95
|
$1.10
|
$1.27
| |
=Abnormal earnings
|
$0.41
|
$0.58
|
$0.67
|
$0.78
|
$0.91
|
$1.06
| |
Valuation
| |||||||
Future abnormal earnings
|
$0.41
|
$0.58
|
$0.67
|
$0.78
|
$0.91
|
$1.06
| |
x discount factor(0.0845)
|
0.922
|
0.850
|
0.784
|
0.723
|
0.667
|
0.615
| |
=Abnormal earnings disc to present
|
$0.38
|
$0.49
|
$0.53
|
$0.57
|
$0.61
|
$0.65
| |
Abnormal earnings in year +6
|
$1.06
| ||||||
Assumed long-term growth rate
|
3.00%
| ||||||
Value of terminal year
|
$19.48
| ||||||
Estimated share price
| |||||||
Sum of discounted AE over horizon
|
$2.57
| ||||||
+PV of terminal year AE
|
$11.97
| ||||||
=PV of all AE
|
$14.54
| ||||||
+Current equity book value
|
$7.41
| ||||||
=Estimated current share price
|
$21.95
|
We can see the model thinks the stock is very cheap, projecting a fair value of just under $22 onto shares. That would imply PRTY is highly undervalued but let's take a look at the fundamentals and see what they can tell us.
PRTY's business model of providing very low cost, consumable items for life events, holidays and seasons is one that has been proven to work very well. It relies on repeat customers because of the consumable and low cost nature of its products but PRTY is capitalizing on consumers' desire to celebrate positive events. In addition, it continues to develop its own private label brands that help it capture more share within the store and margins as sourcing costs are lower. In other words, I like the model and that includes the holiday-specific pop-up stores; PRTY is a well conceived concept and execution on the concept has been there.
PRTY is not a high growth story like other newly public retailers but given its valuation, I think it has enough to warrant a look from the long side. Comp sales in Q2 came in at just 1.2% but it also ceded 150 bps of comp sales due to the shift in the Easter holiday this year. Despite this, the positive comp is a nice result and with PRTY looking to open 30 new stores this year, top line growth should continue to chug along in the mid- to high-single digit range pending what happens with comp sales.
In addition PRTY continues to see higher margins as it builds its own brands in the share of shelf metric. That is the percentage of its own products it sells versus the products it sources elsewhere and that metric continues to improve. Roughly three quarters of the store is now PRTY product and that means further margin improvements will be somewhat muted as that metric tops out. Still, with a quarter of the store remaining, I expect we'll continue to see margin improvements for the foreseeable future although the gains may be smaller than what we saw in Q2.
I do have some concerns surrounding PRTY's balance sheet as the company is heavily leveraged. It has about $1.8 billion in long term debt and another $400 million in short term liabilities against just $1.2 billion in tangible assets. PRTY's balance sheet is much larger than that but it has billions of dollars in intangible assets like trade names and goodwill; things that likely don't have any actual value and cannot be used to produce revenue. That means that a large portion of PRTY's operating income is consumed by interest expense (about $33 million per quarter) and that means profitability is significantly reduced. I never want to see a company spend three quarters of its operating income on interest expense but that is where we find PRTY. That means the company will have to produce significant gains on its operating leverage in order to produce meaningful profit growth. The recent debt refinancing will help but PRTY spends a lot of money servicing debt and investors should be aware of that risk.
Analysts expect PRTY to grow sales at 7% next year and given a moderate comp gain and new store openings, I find that to be reasonable. I expect we'll see a number in that area in 2016.
Profit growth is expected to come in much higher at 24% and while that sounds very high, the fact is that PRTY should achieve some significant cost savings next year. Not only is it busy refinancing expensive debt (and paying some of it down) but it won't have one-time costs associated with going public next year. This is something every newly public company must deal with as first year profitability is always reduced due to these costs. PRTY won't have those next year including a $31 million payment to THL and Advent that was part of going public. That will significantly boost profit margins and given that gross margins are rising through sourcing initiatives, I think we'll see a very healthy boost in profit margins next year, potentially even in excess of the 24% forecast.
That means that at just 13.5 times forward earnings, PRTY is very cheap and potentially even cheaper if I'm right about margin upside. Given that it is still in growth mode and the fact that comps are still solidly positive with decent margin growth, I think we'll see PRTY higher into next year. The company isn't getting any respect right now but with the increase in the number of Halloween City stores this year I think Q4 could be a nice surprise. I like PRTY's model and the stock is just plain cheap.
Disclosure: I am/we are long PRTY.
No comments:
Post a Comment