Pinterest (NYSE:PINS) is a popular social media company with huge free cash flow (FCF). I wrote about the stock last month when it produced a huge 55% first-quarter FCF margin. At the time, I said that PINS stock was worth $79.95, 25% more than its price at the time. But the stock rose 15% to $72.11 on July 13. I decided to take another look since Pinterest will release its Q2 earnings on July 29.
Pinterest’s FCF is so clearly robust that I can raise the value of PINS stock based on its historical FCF margin and FCF yield. Based on my new calculations, I believe that the stock is worth 66% more than its July 13 price — that’s $119.81 per share. For my calculations, I used a higher FCF margin and a higher FCF yield metric than last month.
Keep in mind that as of yesterday, PINS stock is already up 9.4% from last year’s closing price of $65.90. The market has sensed that the company may produce good FCF numbers going forward.
Estimating Pinterest’s Free Cash Flow (FCF)
Here is the scale of Pinterest’s high FCF margins: Last quarter it generated $269.3 million in free cash flow on sales of just $485.2 million. That means its FCF margin was an astounding 55.5% for the quarter. However, for the trailing 12 months (TTM), its FCF margin was just 12.1% based on data from Seeking Alpha.
This FCF margin is very high, especially since most companies are lucky if they see a 20% FCF margin. It means effectively half of every dollar Pinterest makes selling advertisements ends up as pure cash profit.
The margin accounts for cash expenses, including capital expenditures and changes in working capital. All of Pinterest’s normal selling, general and administrative expenses (SG&A), taxes and cash payments have been taken out. That leaves 55.5% of those ad sale dollars “free” to buy back shares, reduce debt, pay dividends, make acquisitions or simply store as cash on Pinterest’s balance sheet.
However, much of its cash generation in Q1 came from changes in working capital, so I don’t feel comfortable using 55.5% margins to estimate future FCF. To adjust for this, I lowered Pinterest’s future FCF margin by 20% to 44.4%.
As seen in the table to the right, Pinterest’s free cash flow can be estimated by using this lower FCF margin against sales forecasts for 2022. Analysts tracked by Seeking Alpha expect an average of $3.45 billion in 2022 sales, up 33.7% from 2021 estimates. That means 2022 FCF will be over $1.5 billion based on a 44.4% margin.
Using FCF Yield to Value Pinterest
Given that this FCF margin is so high, the market puts a high valuation on PINS stock. That is why it now has an FCF yield well below 1% at 0.47%.
Here is how I arrived at that number: Pinterest has a $49.03 billion market capitalization. If we divide its annual FCF by its market cap, we can derive its FCF yield.
For example, in the trailing 12 months leading up to March 31, Pinterest generated $230.5 million in FCF. Seeking Alpha cited a TTM cash flow from operations (CFFO) of $242.1 million. After deducting $11.6 million in capital expenditure spending, TTM FCF was $230.5 million. If we divide $230.5 million by Pinterest’s market cap of $49.03 billion, the FCF yield is 0.47%.
This is a very high FCF yield. I decided to use a much higher FCF yield to value PINS stock. To be conservative, I raised the target FCF yield metric by four times to 1.88%.
So for example, if we divide its 2022 forecast FCF of $1.531 billion by 1.88%, the target market cap will be $81.46 billion. That represents a potential gain of 66%. Based on that calculation, PINS stock should be $119.81, or 66% over yesterday’s price of $72.11.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.