Bottom of the Barrel: Taking a Shine to Coinstar

This operator of coin-counting machines could add jingle to your portfolio.
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Want to transfer that jingle in your pocket to your portfolio? If projections are right,

Coinstar

(CSTR) - Get Report

, which owns and operates automated coin-sorting machines, is about to produce a jingle of its own.

During the technology boom of the late 1990s, the company was a darling of major investment shops like Goldman Sachs, Hambrecht & Quist and Donaldson Lufkin & Jenrette (likely a result of Coinstar's July 1997 IPO). However, Coinstar lost its institutional following in September 1999, and the stock plummeted from over $30 in July 1999 to the single digits only four months later. It was trading at $19.90 Wednesday morning.

Cabbage and Coins

Even without a Wall Street following, the company continued to count its pennies and follow its growth strategy, focusing on partnerships with supermarkets to attract new business. Today, Coinstar has more than 9,100 locations, including revenue-sharing relationships with 19 of the top 20 grocery-store chains in 46 states and the District of Columbia. Its ambitious growth plans center on the 100 largest metropolitan areas, which provide access to 22,000 supermarkets, nearly 75% of the supermarkets in the U.S. today.

Of those 22,000 supermarkets, the company estimates that up to 15,000 locations are ripe for its automated coin-counting equipment. Customers can take their piggy banks, jars and beer cans full of coins, dump them in one of Coinstar's green counting machines and collect their loot, less Coinstar's 8.9% fee for the service. That's not a bad take for a counting robot.

Granted, it takes a lot of coins to make money in this business, something Coinstar has discovered as it still hasn't posted an annual profit. However, in the most recent quarter ended in September, the company posted its first profit of 7 cents a share on a consolidated basis. During the quarter, Coinstar machines processed $389 million worth of pennies, nickels, dimes and quarters.

While estimates predict a loss for Coinstar this year, the company should turn its loose change into profits next year. SunTrust Robinson Humphrey analyst Wayne Johnson thinks the company could earn 25 cents a share in 2002 and says Coinstar is capable of 20% earnings growth over the next five years. He rates the stock a buy, and his firm has not provided banking services for Coinstar.

While Coinstar faces competition from a handful of regional change-counting companies and banks, the convenience of its service makes it the industry leader and has allowed it to grow revenue by more than 30% annually. Furthermore, as growth continues in the U.S., the company has successfully entered the Canadian and U.K. markets and is quietly hoping to expand into other international markets. Coinstar now has 150 machines in the U.K., and Johnson thinks the overseas operation will break-even in the second half of next year.

Finally, the company is in the early stages of test marketing a prepaid MasterCard that would be distributed from its coin-counting machines. The program showed early signs of success in a five-machine test in the Seattle area and is being expanded to a 52-store pilot program in three cities. "Preliminary indications from the company's prepaid MasterCard initiative have been positive with several key metrics -- transaction size, reload frequency and reload value -- exceeding expectations," notes Johnson.

It Takes a Lot of Quarters

Like other growing companies, Coinstar has plenty of risk. Let's face it: Counting coins is not rocket science. Even though the company has a pretty good product, a competitor with a new counting gizmo could challenge the company's dominance in the business, especially a financial institution with deep pockets.

While serious competitors have not emerged in the rather mundane business, the fact that 50% of Coinstar's 2000 sales came from three supermarket chains --

Kroger

,

Albertson's

and

Safeway

-- shows how its success depends heavily on a concentrated customer base.

Moreover, while Coinstar's debt-to-market-cap ratio is only 28%, a chunk of the company's $60 million-plus debt is in high-yield bonds with a 13% coupon. It takes a lot of quarters to make the $8 million in debt service each year until 2006, when the paper matures.

"We are hopeful Coinstar will act soon to either refinance or pay down a portion of its $61 million in junk bonds, which carry a 13% interest rate," says Johnson. "The company generated $3.5 million in free cash from its core operations in the third quarter and has $45 million in cash on the balance sheet, which could be used to pay down this debt and improve earnings per share."

Still, I like the prospects of a company that may have found a way to profit from counting other people's money. While the stock's nice gains since mid-September may cause some near-term consolidation, the path to profitability should cause the jingle in investors' pockets to get both heavier and louder. I give Coinstar 2 1/2 barrels.

For an explanation of our barrel rating system, see our recent description.

Barrel-ology

Six weeks into churning the barrel, the record is decent so far. Four picks are above water, with only

Hibbett Sports

(HIBB) - Get Report

showing a loss. When I

profiled Hibbett, one significant concern was its current price, and I indicated I'd like it better on a pullback. That has happened, and I like the stock at current levels.

Quixote

(QUIX)

has surprised even me. Just days after its

mention here, the company warned that quarterly results would be lower than expected, and the stock sank. Quickly, however, the traffic-barrel maker rebounded and was lately up nicely. The story is still solid, yet the stock's subsequent gain would provide a nice profit for those looking for short-term gains.

I'll provide more color on the performance and updates on the stocks as news warrants.

Do you have candidates for Bottom of the Barrel? If so, shoot me an email with the company name, why you think it qualifies and your full name and hometown. If we profile your suggestion, we'll send you a TSC gift to commemorate your pick.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds' firm was had no positions in any of the securities mentioned, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.