Should I Buy Netflix Stock
Should I Buy Netflix Stock
Updated on November 16, 2022 15:12 PM by Laura Mendes
Shares of Netflix (NFLX 3.65%) surged 14% on Wednesday, Oct. 19, after releasing its third-quarter earnings report on Tuesday night. The streaming video giant's revenue surged 6% year-over-year to $7.93 billion, beating analysts' expectations by $90 million. Earnings per share declined 3% to $3.10, beating consensus expectations by $0.97.
More importantly, Netflix added 2.42 million consecutive paying subscribers, ending its two-quarters loss of subscribers. Do these positive developments suggest it's safe to buy Netflix stock, which remains about 60% below its all-time high last November? Still slowing down.
In April, Netflix shocked investors with its first consecutive drop in subscribers in over a decade. This is largely attributed to increased competition in the streaming space, the effects of the Russian-Ukrainian war, and the sharing of user passwords. It said it would crack down on these shared passwords and introduce a cheaper ad-supported tier to attract new users, but those moves also suggested there were no more opportunities to attract new subscribers.
Netflix's paying subscribers grew in the third quarter as hits like Stranger Things, Monsters: The Jeffrey Dahmer Story, Special Lawyer Wu, Gray Man, and Sandman attracted more viewers.
The company expects paying subscribers in the fourth quarter to reach 228 million, up 2% sequentially (2.6% year-over-year).
Netflix's steady subscriber growth is encouraging, but revenue growth continues to slow. The company attributes the slowdown to its increased reliance on international markets, which offer lower revenues per subscriber than the slower-growing U.S./Canada markets, and the impact of a stronger dollar on international revenues.
As a result, fourth-quarter revenues are expected to increase less than 1% year over year and decline nearly 2% to $7.78 billion. However, at constant exchange rates, this represents an increase of 9% compared to the previous year.
To stabilize revenue growth, Netflix will begin rolling out a cheaper "Basic with Ads" tier on Nov. 3. This is $6.99/month in the U.S. This tier is $1 cheaper than Disney (DIS 1 30%) Disney+ and Hulu's ad-supported tier streams video in up to 720p resolution and features approximately 5-5 minutes of commercials every hour.
On a conference call, COO and head of product Greg Peters said the cheaper ad-supported tier "will attract more members" and will be a "significant additional source of revenue and profit" in the long term. I expected to be deaf. However, Netflix's fourth-quarter earnings suggest those tailwinds will kick in later in the year. These exchange rate issues are powerful.
That Margin Is Still Shrinking
Netflix's third-quarter operating margin was 19.3%, above guidance of 16%, but continued to decline consecutively and year-over-year. She attributes most of the year-on-year decline to the U.S. dollar's rise, likely to continue as interest rates rise.
Combined with infrastructure investments related to new ad-supported tiers, the operating margin is expected to decline to just 4.2% in the fourth quarter. It also expects earnings per share to decline 73% year-over-year.
Netflix must provide an accurate estimate of its fourth-quarter free cash flow (FCF), which will fluctuate significantly based on new content production. However, the company expects to generate about $1 billion in free cash flow for the full year. This means FCF will likely be negative again in Q4 (because he's already generated $1 billion, Three billion FCF in the first nine months).
Its Rating Is Controversial
Analysts expect Netflix's revenue to rise 7% this year, while earnings are expected to fall 10%. Over the next year, assuming we continue to add new subscribers and expand our ad-supported tier, we expect revenue and profit to grow by 8% and 6%, respectively.
Based on these estimates, Netflix is trading at 21 times the expected earnings, which is historically cheap but not cheap compared to traditional media companies. For example, Disney trades at 18 times expected earnings, while Paramount Global (PARA 5.14%) has an even lower price/earnings multiple of 11 times.
At its current growth rate, Netflix deserves to be closer to its legacy media peers offering streaming video platforms rather than high-growth technology companies. As such, I still need to see Netflix as an attractive buyer after recent earnings declines, especially as revenue growth has slowed and operating margins have continued to shrink.