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Here's the One Metric That Matters Most When Netflix Reports Q1 Earnings

Anders Bylund, The Motley Fool

Streaming video veteran Netflix (NASDAQ: NFLX) is gearing up for a first-quarter earnings report, scheduled for the evening of Monday, April 16. Three months ago, Netflix shares rose more than 13% in a single day after reporting analyst-stumping fourth-quarter results.

Stock prices have risen 62% higher in 2018 alone, more than doubling to a 118% gain over the last 52 weeks. Good or bad, this report is likely to start some fireworks in the stock market come Tuesday morning.

Here's what investors should expect -- and look for -- in the first-quarter update.

Netflix's first-quarter guidance

Metric

Q1 2018 Targets

Q1 2017 Results

Expected Year-Over-Year Change

Revenue

$3.69 billion

$2.64 billion

40%

GAAP net income

$282 million

$178 million

58%

GAAP earnings per share (diluted)

$0.63

$0.40

58%

Net additions, U.S. streaming

1.45 million

1.42 million

2%

Net additions, international streaming

4.90 million

3.53 million

39%

Data source: Netflix.

The streaming video giant's profit margins are expected to continue their positive trend from recent quarters. In the year-ago quarter, Netflix converted 6.7% of its revenues into bottom-line earnings. This time, net margins should land near 7.6%. Domestic operations are experiencing some margin shrinkage due to a heavier marketing budget, but international operations are coming to the rescue with rapidly rising profits.

Young couple watching streaming laptop video on their couch, with a large bucket of popcorn close at hand.

Image source: Getty Images.

One metric to rule them all...

The only business metric that's likely to move Netflix's share prices on Tuesday is found overseas. If Netflix beats its international-subscriber growth target, the stock rises. Otherwise, we're probably looking at lower prices for a while. This is Netflix's primary growth engine for the foreseeable future, and investors can be quick to punish any hiccup along the way -- or reward the company for positive surprises.

Profitability matters, but only on a secondary level. I'm keeping a closer eye on the international contribution margin -- 8.7% in Q4 of 2017 and 4.1% in the first quarter of last year -- than on domestic margins or the combined total. For the record, Netflix painted a 13.1% first-quarter target on this important metric.

The company isn't keen on providing firm cash flow targets, but management expects to keep burning more free cash than it makes for a little bit longer. Free cash flows stopped at a negative $2 billion in fiscal year 2017 and should drop to $3 billion or even $4 billion this year.

"We're growing faster than we expected, which allows us to invest more in original content than we had planned," Netflix's management stated in the fourth-quarter letter to investors. "Given our track record of content investments helping to increase growth, we are excited about the growth in future years from the increased investments we are making in original content this year."

More and better debt

In other news. Credit-rating company Moody's recently upgraded Netflix's corporate rating from Ba3 to B1 with a stable outlook. That still is a speculative rating, three steps below "investment-grade" quality, but it's a positive adjustment that will help Netflix bring in more capital through low-cost bond sales and/or bank loans. The ratings agency hailed Netflix's organic growth that's on pace to reach 200 million global subscribers by fiscal year 2021. Over time, Moody's sees this subscriber growth combining with higher consumer-level prices for Netflix's streaming services, bringing cash flows back to positive territory as early as 2022.

Until then, I expect Netflix to continue making use of its improving credit ratings. The company won't announce any new debt offerings in or alongside this earnings report, but management is likely to underscore its commitment to cash-intensive operations and open the door to more debt in 2018. And if the credit rating rises again, Netflix could start to refinance the bonds it sold under more costly terms based on the old Ba3 rating.

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Anders Bylund owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.