Everyone should be happy with Netflix (NASDAQ:NFLX) earnings. Proponents and skeptics alike should see the report as confirming their case. The trading in Netflix stock seems to reflect that: NFLX has moved around, but as of this writing is down just 1% after gaining 3% heading into the release.
I personally have taken both sides of the trade. I called Netflix stock the best contrarian bet in tech during the market-wide selloff late last year. And I backed off that call in February, after a big bounce and amid rising competition.
The Q1 report isn’t enough to move me strongly into either the bull or bear camp. And I suspect that will be true for those investors who more ardently have chosen a side.
The Netflix Earnings Numbers
Fundamentally, Q1 looks like a “good news, bad news” type of quarter. Overall, results were excellent. Adjusted earnings per share of 76 cents came in 19 cents ahead of consensus. Revenue of $4.52 billion snuck just ahead of the average estimate of $4.5 billion.
Guidance for the second quarter, however, was a bit disappointing. Particularly, Q2 EPS was well below expectations, with the company targeting 55 cents against consensus of 99 cents.
The same Q1/Q2 split is seen in the subscriber figures, which I’ve long argued remain the most important metric here. Q1 figures were impressive: Netflix picked up a record 9.6 million subscribers worldwide, exceeding consensus expectations for both U.S. and international growth. In turn, Q2 numbers look somewhat disappointing: subscriber adds in the five million range would actually slow year-over-year, and are about half a million shy of Wall Street estimates.
Overall, the first half — assuming guidance is reasonably correct — looks to be about what should have been expected. The question is whether that’s a good thing for Netflix stock. Shares, after all, have gained 34% this year.
Everybody Wins With NFLX Stock
With a balanced set of pros and cons, traders from all angles are eager to digest the earnings data.
Bulls on Netflix stock will see the report as confirming their thesis that Netflix can, and will, dominate media worldwide. Again, the company added almost 10 million subscribers in just three months. In the seemingly saturated U.S. market, NFLX picked up another 1.74 million subscribers, net. AT&T (NYSE:T) unit DirecTV Now closed 2018 with 1.4 million subscribers, total.
Q2 profit margins do look disappointing, but the company reiterated a healthy 13% operating margin target for the year. And as the shareholder letter noted, the company still is working through price increases not just in the U.S., but Brazil, Mexico and some European countries.
Those increases clearly aren’t slowing subscriber growth, let alone shareholder numbers. Ultimately, they should help margins further in coming quarters.
Netflix bears have some ammunition as well. Competition is on the way, most notably from Disney (NYSE:DIS), whose launch of a new (cheap) streaming service was well-received last week. Disney now has majority ownership of Hulu as well, while Amazon.com (NASDAQ:AMZN) still lurks.
Subscriber growth for Q2 is disappointing. The 13% operating margin target requires improvement in the second half. And as bears like to point out, Netflix is burning cash as it develops its content. In fact, the company raised its cash burn target for the year by $500 million, to roughly $3.5 billion.
Against a $157 billion market capitalization, that cash burn seems dangerous, to say the least. It suggests that Netflix is buying its subscriber growth. When that “opportunity” fades — perhaps with help from Disney and Hulu — its user base will start to shrink. That might spell trouble for NFLX stock.
On the Sidelines With Netflix Stock
From here, the report simply isn’t quite enough to materially change the case for NFLX. The arguments about cash flow seem somewhat short-sighted: Netflix is investing in content that will pay off for years to come, and simply paying the cost upfront.
Plus, near-term cash flow would be much stronger were it just to license content from Disney, AT&T’s WarnerMedia and Comcast (NASDAQ:CMCSA) unit NBCUniversal, and other providers. But the long-term costs would be higher: Netflix would be paying licensee fees in 2026 and 2032 that it won’t have to on its own content.
However, valuation here is intense.
Even with Disney stock soaring of late, Netflix’s market cap is about two-thirds that of its ostensible rival. NFLX stock trades at 57x 2020 EPS estimates. It’s not cheap, or even close. And we saw in Q4 how NFLX responds if market fears rise.
Netflix is an interesting investment, and I see the story as likely to hold for the long-term. But price matters, and unless its earnings wind up leading to a larger decline, Q1 results weren’t enough to make Netflix stock compelling just yet.
As of this writing, Vince Martin has no positions in any securities mentioned.
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