A month has gone by since the last earnings report for Netflix (NFLX). Shares have lost about 1.3% in that time frame, underperforming the S&P 500.
Will the recent negative trend continue leading up to its next earnings release, or is Netflix due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.
Netflix Q3 Earnings Beat, User Addition Target Missed
Netflix reported third-quarter 2019 earnings of $1.47 per share that beat the Zacks Consensus Estimate by 42 cents and was better than management’s guidance of $1.04. Moreover, earnings jumped 65.2% year over year.
Revenues of $5.245 billion increased 31.1% year over year but lagged the consensus mark. Excluding a negative impact of $137 million related to unfavorable foreign exchange, consolidated revenues grew 35% year over year. Moreover, streaming ARPU grew 12%.
Netflix missed its subscriber addition target for the second consecutive quarter. Falling short of its target of 7 million paid subscribers, the streaming giant added 6.8 million, which, however, increased 15.3% year over year.
Moreover, the increase in the paid subscriber base in the reported quarter was much higher than 2.7 million Netflix added in the previous quarter.
At the end of the quarter, Netflix had 158.33 million paid subscribers globally, up 21.4% from the year-ago quarter. The company expected to have 158.56 million paid subscribers, globally.
Price Hike Hurts Retention Rate in US
In the International Streaming segment, Netflix recorded 97.71 million paid members that increased 33% from the year-ago quarter. The company added 6.26 million paid members, slightly better than management’s expectation of 6.2 million, increasing 23.5% on a year-over-year basis.
In the U.S. Streaming segment, Netflix’s paid subscriber base totaled 60.62 million, up 6.4% from the year-ago quarter. The company added 0.5 million paid subscribers compared with expectations of 0.8 million.
The subscriber addition target miss was primarily attributed to the price hike the company announced in January. Netflix stated that subscriber retention rate is yet to return to the “pre-price-change levels”, which affected U.S. subscriber net addition.
However, the price hike has been beneficial for ARPU in the U.S. segment, which increased 16.5% year over year. Excluding unfavorable foreign exchange impact, International streaming ARPU improved 10% year over year.
Content & Viewership Details
Netflix’s Stranger Things 3, Unbelievable, La Casa De Papel, Sintonia, The Naked Director, and Sacred Games were the most viewed shows in the reported quarter. Meanwhile, Secret Obsession, Otherhood and Tall Girl were the most viewed movies.
The third season of Stranger Things was watched by 64 million households in the first four weeks of release. The limited series drama Unbelievable was watched by 32 million households in the first 28 days of release.
Moreover, the third season of La Casa De Papel was watched by 44 million households in the first four weeks of release. This was the most-watched show on Netflix across its non-English language territories.
While The Naked Director was a hit in Japan, the second season of Sacred Games was the company’s most-watched show in India.
The content slate for the fourth quarter includes shows and movies like The Crown, The Witcher, The Irishman from Martin Scorsese and action movie 6 Underground, directed by Michael Bay and starring Ryan Reynolds.
Other notable releases include Marriage Story (starring Scarlett Johansson and Adam Driver), The Two Popes (featuring Anthony Hopkins and Jonathan Pryce), Dolemite is My Name (starring Eddie Murphy and Da’Vine Joy Randolph), Steven Soderbergh’s The Laundromat (starring Meryl Streep and Gary Oldman) and The King (starring Timothee Chalamet, Lily-Rose Depp and Joel Edgerton). The slate also includes animated movies Klaus and I Lost My Body.
During the quarter, Netflix launched a low-priced mobile plan in India.
Moreover, the company’s partner-based bundle offerings expanded in the reported quarter. Netflix is now available on Sky Italia, Canal+ in France, KDDI in Japan and Izzi in Mexico.
In terms of languages, Netflix started offering its services in Vietnamese, Hungarian and Czech.
International Streaming revenues (52.6% of revenues) jumped 39.9% year over year to $2.76 billion. The figure missed management’s guidance of $2.78 billion.
U.S. Streaming revenues (46% of revenues) improved 24.6% from the year-ago quarter to $2.41 billion. The figure was better than management’s guidance of $2.40 billion.
The DVD business revenues (1.4% of revenues) declined 19% year over year to $71.9 million.
Notably, from fourth-quarter 2019, Netflix will start disclosing revenues and membership data by regions, namely Asia Pacific (APAC), Europe, Middle East & Africa (EMEA), Latin America (LATAM), and the United States and Canada (UCAN).
Marketing expenses increased 8.5% year over year to $553.8 million. However, as a percentage of revenues, marketing expenses decreased 220 basis points (bps) to 10.6%.
Consolidated contribution margin (revenues minus the cost of revenues and marketing cost) expanded 640 bps on a year-over-year basis to 30.4%. International and the U.S. streaming segments’ contribution margin expanded 560 bps and 920 bps, respectively.
Notably, from fourth-quarter 2019, Netflix will stop reporting the U.S. and the International segments’ contribution margin.
Moreover, consolidated operating income soared 103.7% year over year to $980 million. Consolidated operating margin expanded 670 bps on a year-over-year basis to 18.7%, better than management’s guidance of 15.9%.
Balance Sheet & Free Cash Flow
Netflix had $4.44 billion of cash and cash equivalents as of Sep 30 compared with $5 billion as of Jun 30.
Long-term debt was $12.43 billion, down from $12.59 billion at the end of the previous quarter. Streaming content obligations were $19.1 billion compared with $18.5 billion at the end of the previous quarter.
Netflix reported free cash outflow of $551 million compared with $594 million in the previous quarter.
For the fourth quarter of 2019, Netflix forecasts earnings of 51 cents per share, implying year-over-year growth of 70%.
Netflix expects to add 7.60 million paid subscribers, lower than 8.8 million added in the year-ago quarter. In the U.S. Streaming segment, the company anticipates adding 0.6 million subscribers. However, in the International Streaming segment, it expects paid subscriber addition of 7 million.
Netflix expects to have 165.93 million paid subscribers globally, up 19.2% from the year-ago quarter. Streaming ARPU is anticipated to grow 9%.
Total revenues, including the DVD business, are anticipated to be $5.44 billion, up 30% year over year. The U.S. and International Streaming revenues are expected to be $2.45 billion and $2.92 billion, respectively.
Contribution profits for the U.S. and International Streaming segments are expected to be $777 million and $309 million, respectively. Moreover, contribution margin for the U.S. Streaming segment is expected to expand 200 bps year over year to 31.6%. The same for the International Streaming segment is projected to expand 670 bps to 10.6%.
Operating margin is projected at 8.7%, up from 5.2% in the year-ago quarter.
For 2019, Netflix now expects net additions in paid subscriber base to decline (26.7 million compared with 28.6 million in 2018) due to higher churn rate and increased competition.
Notably, upcoming streaming services from Disney (DIS - Research Report) , Apple (AAPL - Research Report) , Comcast (CMCSA - Research Report) and AT&T pose a significant threat to Netflix’s streaming dominance.
However, the company reiterated operating margin guidance of 13% for 2019, up 300 bps on a year-over-year basis. Netflix targets another 300-bp improvement in operating margin for 2020.
Moreover, management still expects 2019 free cash outflow to be modestly higher at roughly $3.5 billion. The company still expects free cash flow to improve in 2020 and beyond, driven by increasing member base, revenues and operating margins.
How Have Estimates Been Moving Since Then?
It turns out, fresh estimates have trended downward during the past month. The consensus estimate has shifted -35.83% due to these changes.
At this time, Netflix has a subpar Growth Score of D, however its Momentum Score is doing a lot better with an A. However, the stock was allocated a grade of F on the value side, putting it in the fifth quintile for this investment strategy.
Overall, the stock has an aggregate VGM Score of D. If you aren't focused on one strategy, this score is the one you should be interested in.
Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, Netflix has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
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