Netflix (NASDAQ:NFLX) stock appears to have neared a crossroads. For most of its history, its strategic vision has made Netflix a pioneer in its industry. This has taken Netflix stock to stratospheric valuations.
However, with a generalized slump in tech equities and the coming of a formidable direct competitor in Disney (NYSE:DIS), NFLX could struggle to support its lofty multiple.
Strategic Vision and Netflix Stock
Amid increasing pressures, few companies in American business have matched the strategic prowess of Netflix. It supplanted the once-unstoppable Blockbuster with its mail-order DVD business.
It then went on to pioneer the streaming industry that put pay-TV providers on the defensive. When streaming began to become passé, it started to develop its own content and bring streaming to virtually all corners of the world.
Thus far, it has handled competition from the likes of Hulu, Prime by Amazon (NASDAQ:AMZN), and HBO, a channel now owned by AT&T (NYSE:T). However, Disney will soon launch its own Disney+ service. This harms Netflix’s content advantage as Disney’s content library moves from Netflix offering to a competing product.
To the credit of Netflix stock, the company has produced large amounts of award-winning content. This has kept Netflix’s subscriber base growing.
However, this has also come at the cost of negative cash flow despite an expected profit growth rate of 56.4% this year. The company spent an estimated $12-13 billion on content in 2018.
This resulted in a negative cash flow of $3 billion for 2018 alone. Analysts expect another $3 billion in negative cash flow in 2019.
Netflix Has Little Margin for Error
Such pressures further highlight the multiple on Netflix stock. While the recent drop in tech stocks has hammered NFLX, its forward price-to-earnings (PE) ratio comes in at just over 64. In previous writings, I wrongly predicted investors would bail out of NFLX stock as the PE ratio marched higher.
However, such PE ratios become harder to justify as streaming moves from a visionary offering to a mainstream product. Netflix built its advantage on becoming the first company to make these offerings.
However, Disney’s superior content library and promise to charge a lower fee could negate Netflix’s first-mover advantage. Moreover, Disney can also earn money from showing movies in theaters and selling merchandise. Netflix’s only source of revenue remains its subscriber base.
That said, I do not expect a “doom and gloom” scenario for Netflix as a company. Analysts predict average profit growth of 61.6% per year for the next five years.
I also expect Netflix to remain at number one or number two in the streaming business for the foreseeable future.
Uncertainty Will Define Netflix
Unfortunately, the firm’s challenges will likely inflict further pain on NFLX. The question remains whether NFLX falls a little more or a lot further. I do not believe the PE will sink much lower than the growth rate if it holds its own against Disney. However, investors may begin to doubt the 61.6% estimated long-term growth rate if viewers leave Netflix for Disney in droves.
Those who lived through the 1990s dot-com bubble can remember that even some of the more solid tech companies lost 75% or more of their value. Those who think this cannot happen to Netflix stock ignore history.
So far, NFLX stock has fallen by about 36% from its 52-week high. If Disney+ reduces Netflix’s growth rate, or if cash flows force a cut in content budgets, it could spell further trouble for NFLX.
Concluding Thoughts on Netflix Stock
The ability of NFLX to maintain its high PE ratio depends on how well it competes with Disney+. While Netflix has stayed ahead of its peers, it has come at a heavy cost to its balance sheet. Even with Netflix’s popular content, it could struggle against Disney’s deep repository of movies and TV shows.
Moreover, with the forward PE above 64, negative news could easily push NFLX down. While Netflix may ultimately hold up well against Disney, Disney+ will at least bring uncertainty for the foreseeable future. That’s enough to make Netflix stock a sell for now.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
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