Netflix’s Season Finale As A Purchase Prospect Was Spectacular (NFLX)

In relation to streaming, in all probability no firm is as well-known as pure play streaming large Netflix (NASDAQ:NFLX). The corporate provides the biggest single streaming service on the planet and, regardless of fears on the contrary, it has, over the years, defied expectations and achieved reasonably outstanding development. A few of this has even come at a time when the market was fearful that the streaming markets have been saturated. And it is all a testomony to good administration, good branding, and high-quality content material.

For an extended whereas, I used to be skeptical in regards to the firm as an funding alternative. This was due to how dear shares have been and since I used to be apprehensive that the dearth of non-streaming sources of income and money movement would lead to different gamers coming into the streaming house outspending it to construct extra sturdy companies with large libraries of content material to help them. Whereas shares have remained dear, the latter worry proved to be incorrect, at the least up so far, as different streaming companies have aimed to chop prices by decreasing content material spending, and as development achieved by Netflix has accelerated.

In the end, this led me to upgrade the inventory from a ‘maintain’ to a ‘purchase’. That occurred again in October of final yr. And since then, shares have shot up 50.9% whereas the S&P 500 is up 16%. And since my final ‘purchase’ article on the corporate in January of this yr, shares are up 13.5% in comparison with the two.5% rise seen by the broader market. Sadly, all good issues should come to an finish, although. And based mostly on results just released protecting the primary quarter of 2024, I consider it is applicable to downgrade the agency to a ‘maintain’. Imagine it or not, this has much less to do with the precise outcomes posted by administration and extra to do with how dear the inventory has turn out to be. However along with that, one other growth occurred throughout the quarter that flashes warning indicators to me.

A strong quarter

Basically talking, Netflix had a very strong quarter. Income, as an illustration, got here in at $9.37 billion. This represents a rise of 14.8% in comparison with the $8.16 billion generated within the first quarter of 2023. Along with this, it is $90 million greater than what analysts anticipated, and it is $130 million above what administration had forecasted. Whereas the corporate has began producing income from promoting, the majority of its development appears to have come from an increase within the variety of customers on the platform. The variety of paid members totaled 269.60 million throughout the first quarter of 2024. That is up 9.32 million, or 3.6%, from what was seen one quarter earlier, and it occurred to be 37.10 million, or 16%, greater than the 232.50 million that the corporate reported for the primary quarter of 2023.

Those that observe the corporate carefully would possibly recall that administration has been focusing extra on producing promoting income. Not way back, the corporate even launched a model of the membership that features ads. To date, that appears to be understanding fairly properly. Adverts membership grew by 65% within the first quarter of the yr in comparison with what it was within the closing quarter of 2023. That was after rising 70% from the third quarter to the fourth quarter. In line with administration, over 40% of all signups in its adverts markets got here from its adverts plan.

Geographically talking, development in subscriber depend was achieved throughout the board. Within the US and Canada area, the corporate achieved 82.66 million paid members throughout the quarter. That is up from the 80.13 million reported for the third quarter, and it compares favorably to the 74.40 million reported one yr in the past. Within the EMEA (Europe, Center East, and Africa area, the subscriber depend was 91.73 million. That is up from the 88.81 million reported within the fourth quarter of final yr, and it compares properly to the 77.37 million reported the identical time final yr. Within the Latin America area, the corporate boasted 47.72 million subscribers. That is up from 46 million one quarter earlier and up from the 41.25 million reported one yr in the past. And lastly, within the Asia Pacific area, the 47.50 million paid members beat out the 45.34 million reported solely three months earlier, and it beat out the 39.48 million reported one yr in the past.

As a lot as I wish to say that income per membership elevated, that was not the case in all areas. As you’ll be able to see within the chart above, the corporate noticed a drop in common income per membership from $8.60 within the closing quarter of final yr to $8.29 the primary quarter of this yr in the case of the Latin America area. However in all different areas, the corporate posted respectable development. Most notably, within the US and Canada, common income per member totaled $17.30. That is up 4% in simply three months, and it is up 6.9% yr over yr. Whereas this may occasionally not sound like a lot, whenever you apply this improve to the variety of paid members that the enterprise had throughout the US and Canada within the first quarter of the yr, it really works out to a further $1.11 billion in income.

On the underside line, the image was largely optimistic. Earnings per share of $5.28 dwarfed the $2.88 per share reported one yr in the past. It was additionally $0.76 per share larger than what analysts anticipated. Plus, it was $0.79 per share, or $356 million, greater than what administration had forecasted. To be honest, not all of that is due to a development in income and cost-cutting. The corporate did profit from a $131 million non-cash unrealized achieve involving international forex take away measurements on its euro denominated debt. However even with out this, the underside line got here in higher than anticipated. Different profitability metrics weren’t as spectacular. Working money movement inched up solely barely from $2.18 billion to $2.21 billion. But when we alter for adjustments in working capital, we get a decline from $2.24 billion to $2.11 billion. In the meantime, EBITDA for the corporate fell by $2 million, although it nonetheless rounds out to $2.57 billion on the finish of the day.

It is also value noting that the corporate got here out with some reasonably rosy steering for the second quarter of the yr. If all goes in response to plan, income within the second quarter needs to be round $9.49 billion. Analysts have been anticipating $9.28 billion. Earnings per share, in the meantime, is anticipated to return in at round $4.68. That compares favorably to the $4.54 per share that analysts had been forecasting for the second quarter of the yr. This exhibits that administration is doing properly, not solely from a income perspective, but additionally in the case of profitability.

Given how strong the quarter occurred to be, you is perhaps stunned that I am downgrading the inventory. However it actually boils down to 2 causes. At the start, shares have gotten fairly dear. As I discussed close to the beginning of this text, shares are up, excluding the after-hours share worth decline of 5%, 50.9% since I first turned from impartial to bullish on the corporate final yr. If we use outcomes from 2023, the inventory is buying and selling at 34 occasions the worth to adjusted working money movement a number of. In the meantime, the EV to EBITDA a number of of the corporate is a hefty 29.1. I acknowledge that development has been enticing as of late. That is very true for an organization of this measurement. However I’ve a tough time digesting such a lofty a number of. This doesn’t suggest that I’m pessimistic in regards to the firm from an operational standpoint. The truth is, there’s a lot that buyers should stay up for.

In a turnings launch, as an illustration, administration introduced various attention-grabbing factors and a change in how they will be doing enterprise shifting ahead. Viewership, as an illustration, for a lot of of its prime exhibits has been completely phenomenal. In the course of the first quarter alone, Idiot Me As soon as, introduced in 98.2 million views. There have been different massive title exhibits as properly. Griselda introduced in 66.4 million views, whereas Avatar: The Final Airbender introduced in 63.8 million views. One film, Society of the Snow, boasts to 98.5 million views, making it the second hottest non-English language film of all time in response to administration. One other massive win concerned Damsel, which noticed 123.9 million views. This was adopted up by Carry with Kevin Hart at 113 million.

You’d assume that, with such massive viewership numbers, the corporate can be dominating all video viewing. However you’ll be underestimating simply how giant the video viewing house is. In line with administration, the corporate’s share of complete TV viewing is lower than 10% in each nation wherein it operates. And even whenever you deal with the US market that the corporate has such a pleasant chunk of, it has solely 8.1% of all TV viewing, which is not even a majority of the streaming market that accounts for a complete of 38.5% of all TV viewing within the nation. Exterior of content material and issues like that, it is also value noting that the corporate has been paying down debt and shopping for again inventory. They paid down $400 million value of senior notes throughout the first quarter of the yr, utilizing money that was readily available. Additionally they repurchased 3.6 million shares for roughly $2 billion. With 2024 as an entire anticipated to lead to $6 billion value of free money movement, which is even after factoring in $17 billion in money content material spending, it is doubtless that further debt discount will happen, and that extra share buybacks will happen. Nonetheless, given how dear the inventory is, I believe the money may very well be used for one thing greater than share buybacks.

With this in thoughts, administration did say that they intend to alter issues shifting ahead. Prior to now, they’re all the time centered on sustaining gross debt of between $10 billion and $15 billion, with money balances equal to roughly 2 months of income. They have not offered any actual particulars, however they did say that they’ll transfer away from that, however with the purpose of making certain the existence of a ‘wholesome’ steadiness sheet with ‘ample liquidity’. They did say that they’ve determined to upsize their revolving credit score facility from $1 billion to $3 billion. However I do not essentially know if this may elevate debt in the long term. If something, it should create some further volatility in how a lot debt exists from quarter to quarter. Administration did say that they do not plan to borrow with a view to purchase again inventory, so that could be a optimistic.

The one different factor that bothers me, moreover how dear shares are, is among the different adjustments that administration is making. That is that administration has determined, efficient with the primary quarter of 2025, they’ll not be reporting quarterly membership numbers or common income per member. Their justification is that, as they begin producing sturdy money flows and as they begin producing income from different sources like promoting and various kinds of memberships, that these are higher metrics than the variety of paid memberships and common income per member. I wholeheartedly disagree. These knowledge factors that they’re forgoing will create opacity and can make it tough to note adjustments in development and to doubtlessly level out ought to the corporate begin to see a decline in membership. I perceive the necessity to provide you with further metrics. However the reply is to not cast off others in favor of latest ones. Somewhat, it’s to proceed to report the previous ones, whereas including to them and modifying them as wanted.

Takeaway

In the long term, I absolutely anticipate that Netflix will do properly for itself. However this does not imply that the corporate makes for a compelling alternative proper now. Shares have seen large upside since I turned bullish in regards to the agency. However in all honesty, I view additional upside as unlikely, at the least relative to what the broader market will obtain. Due to this and due to the change in what the corporate plans to report beginning early subsequent yr, I consider {that a} downgrade to a ‘maintain’ score is smart.