iParty Corp. (IPT) operates 51 retail stores spread throughout New England and Florida. The company stocks over 20,000 products ranging from paper party goods and Halloween costumes to greeting cards and balloons.

The business is heavily dependent on holiday and party events like anniversaries and graduations, along with major holidays like Easter, Christmas, and Halloween.

Although the business is highly cyclical in nature during a given year, the company has been profitable for four out of the last 5 years (with the only hiccup being a loss in 2008 during the depths of the recession).

A string of recent insider buying and the upcoming Halloween season should help drive record profitability and free cash flow for this nano-cap stock.

Financials

Revenues have remained flat since 2006, falling into a range of $78-82M. Revenue increases are primarily driven from opening new stores – new store growth has slowed in the past few years as the company cut back during the recession.

5-yr median CROIC (11.4%) and ROE (5.1%) are unspectacular, but have risen substantially over the past several years. 2009 CROIC was 28.8% and it looks like 2010 will be in the same territory as well.

Debt to equity is high, at 148.4% in the most recent quarter – this number should come down after fourth quarter results. 2009’s debt to equity was 123.5%, down significantly from 243.9% in 2005.

IPT’s assets are tied up in inventory rather than cash or other liquid assets, and the company’s credit line is backed by this inventory. Hence, the quick ratio is very low, and the company’s Z-score could be improved.

While the balance sheet doesn’t compare to other stocks recently featured (JCTCF and APT for example), the company does have quite a bit of room left in its credit line, and has produced solid free cash flow each year since 2006.

On the income statement, management has done a great job of cutting costs so far in 2010 despite the flat sales. SGA expenses as a percentage of revenue was 36% in the second quarter of 2010, compared to an average of 45-50% in prior years.

Positives

Insider Buying

Five different insiders have been purchasing shares over the past year at prices ranging from $0.26-$0.30. In total, 346k shares were purchased, almost 1.5% of shares outstanding.

Several recent purchases in August and September should be a positive sign for the upcoming earnings release.

Increase in Comp Store Sales

After seven consecutive negative quarters for comp store sales, the company returned to growth for both the first (+1.3%) and second quarter (+1.4%) of 2010.

As a key metric for most retail businesses, this is a good sign going into IPT’s busiest time of the year, especially since 2009 was the best year in company history from both a net income and cash flow perspective.

Store Footprint

IPT opened its first city-based store in downtown Boston in December 2009. The company expects to open another store in a prime urban location before the 2010 Halloween season.

If management is correct, both should help drive increased exposure and sales for the fourth quarter.

In addition, the company has also increased its focus on temporary Halloween stores. It opened 4 temporary stores in 2009 compared to only 2 in 2008.

These temporary stores provide some flexibility to react to market trends, as the company can control its costs to some degree depending on the sales environment.

Negatives

Risk of Dilution

IPT currently has 5 different series of preferred shares, in addition to outstanding warrants for its common stock.

Combined, the preferred shares can be converted into approx. 15M shares of common stock, a significant number that could potentially lead to dilution for existing common shareholders.

The bulk of the warrants resulted from a 2006 financing agreement with Highbridge Capital – they carry an exercise price of $0.48/shr and currently expire in September 2011.

Cyclical Sales

IPT traditionally has reported a loss in its fiscal 1st quarter and 3rd quarter. The vast majority of profits come in the fourth quarter, with both the Halloween and Christmas holidays.

Other major events (such as the New England Patriots making it to the Super Bowl) can also have a dramatic effect on the company’s revenues. These fluctuations must be carefully managed and sometimes make investors nervous.

Although the company has done a great job in controlling SGA expenses, sales have stagnated around $78-80M.

There are only so many costs that can be wrung out of an organization, so top-line growth will have to come from somewhere (the urban-store expansion?) in order to propel the business further.

Valuation

Assuming the company ends the year with $0.05 EPS, that translates into a P/E ratio of 5.6 at current prices.  Applying a normal P/E multiple of 10 leads to a price of $0.50, in line with the other valuation methods.

Conclusion

This year is shaping up to a stellar year and insiders have been extremely bullish going into historically the best quarter for the company.

Management has done a good job of controlling costs throughout the economic downturn and has resumed their store expansion strategy which should help drive sales growth (while keeping some flexibility with the temporary store locations).

The company is backed by top venture capital firms.

Robert H. Lessin, now the Vice Chairman of Jefferies & Co, owns approx 35% of the company and appears to be a rockstar in the angel industry on the East Coast, providing seed investments to Overture and Register.com.

Other current holdings by Roccia Partners, Highbridge International, Boston Millenia Partners, and Patriot Capital all provide positive reinforcement that the industry believes in the company.

Finally, another catalyst happens to occur in October 2010 – this month has five full weekends (5 Fridays, 5 Saturdays, & 5 Sundays).

The last time this occurred in October was 2004. It won’t happen again until 2021, but for a company like iParty that depends on Halloween, it should provide opportunity for shoppers to hit the stores, translating into a nice sales boost!

I’m adding IPT to the Value Uncovered portfolio at yesterday’s closing price of $0.28.

Disclosure

Long IPT

It’s been a wild ride this year, as the S&P 500 posted a 8.9% gain in September after falling 4.5% the previous year.

My model portfolio returned to positive territory and is still beating the market overall.

Check out my current holdings.

Stock Positions

I added one new stock to the model portfolio this month, in Alpha Pro Tech (APT). The company experienced a record year in 2009 due to a strong tailwind in the company’s core industry.

Management has done a great job of preserving APT’s balance sheet, and the stock remains undervalued despite several upcoming catalysts.

The rest of my positions remain stable – the big winner for September was Servotronics (SVT), posting a 18% gain for the month.

Watch Lists

I also wrote about another stock that I plan to keep on the watch list going forward. Jewett-Cameron (JCTCF) is a micro-cap company that has grown book value by almost 12% per year.

I’ll be adding a new section to the website in order to track stocks I’ve written about but haven’t purchased (such as JCTCF, SIF, VII, & VIFL). For many, I’m waiting for a better entry point to ensure a strong margin of safety.

Special Situations

It was definitely an up-and-down month for the special situations investments.

I added a new position in NexCen Brands (NEXC), my first liquidation play. The transaction should play out over the coming months but I think there is strong incentive for the consulting firm to pay-out on the higher end of the distribution range.

AHOM wrapped up its going private transaction – a bit behind schedule, but a transaction that still offered 72% annualized returns.

The big hit came after the cancellation of the EMMS going private transaction. After a long, drawn-out negotiation process, the financier behind the transaction finally walked away despite management’s best efforts to finalize the deal.

Lawsuits have followed and the stock languishes now under $1/shr, far below the original buyout price of $2.40.

It was a rough investment, costing the portfolio almost 2%, but offered many lessons going forward.

Performance

I will probably start updating my performance on a quarterly basis, if only to reinforce the fact that value investing should be focused on the long-term perspective vs short-term fluctuations in the market.

Disclosure

Long APT, SVT, NEXC

Jewett-Cameron Trading Company Ltd. (JCTCF) is another micro-cap industrial stock that has flown under most investors’ radars. The holding company can be broken out into 4 different segments:

• Greenwood Products: Industrial wood products, major product category is selling treated plywood to boat manufacturers.
• Jewett-Cameron Lumber Corporation (JCLC): Lawn, garden, pet and other, Sold primarily to home centers and other retailers.
• Jewett-Cameron Seed Company (JCSC): Seed processing and sales
• MSI-PRO: Industrial tools and clamps, sells pneumonic air tools, industrial clamps, and saw blades.

Business Segments

2009 was an extremely difficult year for JCTCF, as sales dropped 35% to $42.1M. This reduction in revenue led to a sharp decrease in net income – $0.66/shr compared to $1.09/shr in 2008.

Although sales were down basically across the board, the largest drops occurred in the wood products (-59%), and seed processing segments (-41%).

The wood products business has struggled mightily since 2005, falling almost 80% from peak sales of $55.38M. Boat manufacturers have been hit really hard by the recession, as dealers work through inventory backlog and consumers delay purchases.

Management does not believe that the boat manufacturing business will return in the near future:

“We continue to develop a readiness to participate when the market rebounds. In the meantime, we have been searching for alternative uses for our industrial wood products and developing new customer relationship”

Looking at the operating segments, JCTCF operates in a tough business environment with low single digit margins in 3 out of 4 business segments (similar to a current holding, APNC.OB, with its insurance marketing division).

The product mix has shifted towards the higher margin JCLC business, which now makes up almost 60% of sales. The company is transforming (maybe involuntarily?) into a business that relies on the lawn, garden & pet segment to drive profits.

Despite the revenue declines, the overall business remained solidly profitable in all four quarters in 2009, a trend that has continued into the first three quarters of 2010.

Company Financials

JCTCF has aggressively paid down debt, reducing its debt to equity ratio from 137.2% in 2003 to 9.6% last year – the company has no long-term debt outstanding, but has an unused $5M credit line available.

Overall, gross margins have improved as the company makes the transition into the higher margin lawn & garden business – TTM gross margin of 22.3% is the highest on record.

The balance sheet is extremely strong with a current ratio and quick ratio of 4.9 and 3.2 respectively. The company is sitting on a huge cash pile ($8.4M) or $2.71 per share in net cash after subtracting out liabilities.

CROIC & ROE have plateaued in the past five years at 10.3% and 15.3% respectively.

Risks

Management Team

The company’s CEO, Donald Boone, and Corporate Secretary, Michael Nasser, collectively control over 35% of outstanding shares.

Both executives have been with the company since 1987 and have seemed content to sit back and watch the cash position grow without any urgent concern for minority shareholders (although a recent stock buyback could be a step in the right direction).

Decline in Revenues

Sales have declined every year since 2006, and are currently almost half of the high water mark. The company’s language in the quarterly report continues to have a negative outlook on the boating sector, which used to be the major source of revenue.

If management cannot effectively guide the company into growing business segments, JCTCF’s long-term prospects could be suspect.

Positives

Share Repurchase Program

After announcing in July 2009 that the company began exploring options to increase shareholder value, management finally announced a stock repurchase program in May of this year for up to 425,000 shares, or 17.8% of the total shares outstanding.

Unusually, the company designated specified in the press release that it would only buy shares for up to a maximum of $7.00.

As of July 6, 2010, the company had purchased almost 80k shares with a month left to go in the original program. Assuming the company maintains this pace, the company would retire approx 7% of shares, making the company appear even cheaper.

Hidden Undervalued Assets

Property, plant and equipment is currently being carried at approx $1.9M, net of depreciation. However, the company owns several pieces of extremely valuable property:

“The Company’s executive offices are located at 32775 NW Hillcrest Street, North Plains, OR 97133. The 5.6 acre facility, which is owned, consists of 40,000 square feet of covered space (6,000 office, 10,000 manufacturing, and 24,000 warehouse), a little over three acres of paved yard space, and was completed in October 1995”

The property associated with JCSC, which is owned, consists of a little over 13 acres of land, 105,000 square feet of buildings, rolling stock, and equipment. It is currently used for seed processing and storage. It is located at 31345 NW Beach Road, Hillsboro, OR 97124, which is adjacent to North Plains, OR”

In all, the company owns almost 150,000 square feet of building space and almost 19 acres of in a prime location in Oregon right near a small airport and a major highway.

A quick search in Loopnet shows comparable buildings selling for approx. $17-$20/sq. ft. Undeveloped land is going for approx. $200k-$300k per acre.

At those prices, the land alone is worth over $3m and yet is sitting on the balance sheet at $635k.

Rebound in Boat Manufacturing

Although the company’s reports have been very negative on the status of boating manufacturers, other industry statistics show a glimmer of hope on the horizon.

As of July 2010, boat sales remain down 15% YoY but have been rising steadily since April 09.

As sales rebound, dealers will continue to work through their inventory backlog – an increase in manufacturing will follow, leading to increased sales for JCTCF.

While the Greenwood Products division will probably not see 2005 levels for quite some time, a resumption in sales growth and return to profitability in this segment will certainly help the stock.

Valuation

Using an estimated 2010 EPS of $0.80, JCTCF’s P/E ratio is 8.75, slightly below its long-term average.

After adjusting the P/E ratio to include the net cash balance ($2.71/shr), the modified P/E ratio is only 5.3.

JTCF is also selling at discount to book value as well as NCAV.

Conclusion

Over the past few years, the JCTCF managed to stay profitable, on both an earnings and cash flow basis, during an extremely difficult period and despite revenues cratering in the main business segment.

The stock is trading at a discount to its intrinsic value, and management now has the responsibility of guiding the business back to growth.

Although the share buyback is a nice gesture, management could do more – a special dividend or possible sale of one of the underperforming business segments would be a nice catalyst for future price appreciation.

Disclosure

No positions in my personal portfolio at the time of this writing.