Coinstar (CSTR) leaped almost 20% higher on Friday after a very solid earnings report and upwardly revised guidance, as the rest of the market slipped nearly 2%.  It would be entirely understandable for a stock to take a little bit of a breather after such a day, but on Monday afternoon the company had tacked on another 7.7% in heavy volume.  At the time of writing, the stock has surged 72% higher year to date, and may not be finished yet according to our valuation.

Coinstar’s first quarter was stronger than expected as earnings of 21 cents per share easily topped estimates of 13 cents per share.  Sales of $350.1 million were 47% higher than a year ago and also topped expectations on Wall Street.  The DVD rental business was the clear driver of results as their other divisions experienced revenue declines.  Clearly, they have found their niche as they place their Redbox kiosks in high traffic consumer spots like grocery and drug stores.  For the second quarter, the company was a little more cautious than consensus analyst expectations, but their outlook for the full fiscal year was well ahead of estimates.  For the year, Coinstar expects revenue of $1.53 to $1.63 billion, EBITDA of $275-$290 million and earnings per share of $1.82 to $1.94.  Consensus analysts had pegged 2010 results to be EPS of $1.60 on sales of $1.51 billion, so clearly the companyCSTR expects strong performance through the balance of the year. 

Part of the reason for the stock’s recent performance is likely due to a short squeeze situation, where short sellers are confronted with a much stronger earnings report than expected and they must quickly cover their position in order to avoid further risk.  With the struggles in the DVD rental industry recently, it is not hard to imagine why so many bet against this relative newcomer in the industry.  Blockbuster (BBI) once the industry’s titan has been plagued with bankruptcy rumors and their stock has languished below $1 for some time.  Over the weekend, Movie Gallery announced that they would shutter their remaining stores as the once proud Hollywood Video bites the dust.  Furthermore, Coinstar must contend with the super hot Netflix (NFLX) as well as other means of rental such as through a cable provider.  Coming into their earnings release, Coinstar had about 28% of its shares held short as some traders doubted their business model.  The combination of their solid earnings, great guidance, short covering, and now a competitor closing its doors has given the stock an extremely impressive run.

Value investors may want to wait for a pullback after such a hot run, but according to our methodology Coinstar’s price is not out of line with fundamentals.  We are maintaining our Undervalued stance as of this week’s report, as the stock edge closer to our fair value estimate of around $53.  If the company is only able to meet the low end of its 2010 guidance it still trades below its historically normal valuation ranges.  For example, at the low end of the estimate CSTR would trade for .97x sales per share, while the market has historically been willing to pay between 1.14x and 2.03x times sales per share.  Price-to-cash earnings for CSTR over the last ten years has historically ranged from 15.5x to 28.0x, our current estimate for cash earnings (excludes non-cash events) for the full year is about $3.25 per share, which we believe is conservative.  So CSTR is currently trading for 14.6x price-to-cash earnings, another sign that the stock remains undervalued in spite of the recent rally.

Coinstar’s business model is proving effective as some competitors struggle to hold market share.  A stock that has appreciated as much as CSTR has recently is generally not a typical value play, but with this one we do not think the price has gotten too far ahead of fundamentals.  We see further potential for gains in this stock as it expands its reach and grabs market share.

Coinstar’s Redboxes Remain Red Hot