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Elevator Pitch
My investment rating for Netflix, Inc.’s (NASDAQ:NFLX) shares is a Hold. In my earlier update for NFLX published on February 16, 2022, I focused my attention on Netflix’s stock price weakness for the month of January. I preview NFLX’s Q2 2022 earnings in this latest article.
Netflix’s upcoming quarterly financial results won’t be good, but investors’ expectations are already very low which implies that the chances of revenue or earnings misses are not high. Also, NFLX’s current mid-teens forward P/E valuation multiple has largely factored in the company’s weak near-term outlook. Therefore, NFLX isn’t a Sell.
However, Netflix doesn’t deserve a Buy rating either. The market expects NFLX to generate stronger revenue growth and achieve an improvement in its profitability starting in FY 2024. I think this is too bullish, since Netflix has yet to prove that it can deliver on its ad-supported tier and shared login crackdown initiatives. As such, NFLX is a Hold in my opinion.
NFLX Stock Key Metrics
There are a number of key metrics relating to NFLX’s stock that one needs to watch prior to analyzing the company’s future financial outlook.
A June 28, 2022 Variety article cited Whip Media’s 2022 Streaming Satisfaction Report which highlighted that “Netflix ranks last among streamers for perceived value.” According to Whip Media’s survey results, “69% of former Netflix customers said the price increases led them to drop the service.”
Whip Media’s research findings are consistent with the subscriber data provided by Antenna, which indicates that NFLX’s US “Active Monthly Churn Rate increased +0.95pts month-over-month in Jan-22” after implementing a new round of price hikes. The +95 basis points jump was the most significant month-on-month increase in churn that Netflix has experienced since September 2020.
To tackle the issue of churn, Netflix has two key initiatives in place to help the company deliver subscriber growth in the future. The first initiative is the introduction of a new ad-supported subscription tier; the second initiative is the crackdown on shared logins.
But NFLX’s plans might not be successful based on an evaluation of certain metrics.
MIDiA Research’s recent July 5, 2022 article mentioned that “Netflix subscribers are likely to view the pivot (to an ad-supported tier) less favorably”, as the proportion of NFLX’s subscribers who “do not want ads on any type of (paid) video service” is higher than “the weighted consumer average” based on the firm’s research. In other words, the sign-up rate up for Netflix’s ad-supported tier in the future might not be as good as hoped for.
Separately, a commentary published by S&P Global on June 22, 2022 noted that “Netflix users (in the US) who indicated sharing a log-in tended to be younger, less educated and have lower income than other subs” based on a survey done by Kagan. This implies that NFLX’s crackdown on shared passwords might not lead to an increase in paid subscriptions, given that those who are sharing logins tend to have lower purchasing power.
I discuss Netflix’s future growth prospects in the subsequent sections of this article, in consideration of the metrics highlighted in this section.
When Does Netflix Report Earnings?
Netflix will be reporting its earnings for the second quarter of 2022 on July 19, 2022, as per the company’s prior announcement on June 15, 2022.
What To Expect From Earnings
The expectations for NFLX’s Q2 2022 financial performance are poor.
There are 44 sell-side analysts covering Netflix. An estimated 30 Wall Street analysts lowered their respective second-quarter top line forecasts for NFLX in the last three months, and no single analyst raised his or her Q2 revenue estimate for Netflix during the same period. The consensus financial projections point to NFLX’s YoY revenue growth slowing from +19.4% in Q2 2021 and +9.8% in Q1 2022 to +9.6% in Q2 2022.
Similarly, 16 sell-side analysts revised their Q2 2022 EPS estimates for Netflix downwards in the past three months, as compared to a relatively lower number of analysts, 11 to be specific, who increased their second-quarter bottom line forecasts for NFLX. The market consensus expects NFLX’s non-GAAP adjusted EPS to contract by -16% QoQ from $3.53 in Q1 2022 to $2.97 in Q2 2022.
I think that the consensus Q2 2022 numbers for Netflix are realistic, and I am of the view that NFLX’s financial performance in the second quarter of this year should roughly meet market expectations with revenue and earnings beats (or significant misses) being unlikely. A weak macroeconomic environment, stiff competition, and elevated content spending are the key factors that will be a drag on Netflix’s financial performance in Q2 and subsequent quarters.
How Profitable Is Netflix?
Profitability is another key metric for NFLX, on top of other metrics like revenue growth and subscriber churn.
On the FAQs section of its investor relations website, Netflix emphasized that its “annual GAAP operating margin” expanded from 7% in FY 2017 to 21% in FY 2021. During this period, NFLX’s non-GAAP normalized net profit margin also grew from 4.8% to 17.2% as per S&P Capital IQ data.
Looking ahead, NFLX guided in the FAQs section of its IR website that it targets to achieve an operating profit margin of 20% in “our current period of slower revenue growth”, and it stressed that “we intend to steadily grow our operating margin” when “we re-accelerate revenue growth.”
In the next section, I touch on NFLX’s long-term financial forecasts in terms of profitability and top line expansion.
What Is Netflix’s Long-Term Forecast?
The sell-side’s consensus financial projections for Netflix in the long run are aligned with the company’s profitability guidance stated on its investor relations website that was referred to in the preceding section.
The analysts see NFLX generating operating profit margins of 19.6% and 20.4% for fiscal 2022 and 2023, respectively; and the company is forecasted to deliver annual revenue growth rates under +10% in these two years. For the FY 2024-2026 period, Wall Street expects Netflix’s yearly top line expansion to accelerate to 10% and above, which will support the expected improvement in Netflix’s profitability. The market’s consensus financial forecasts indicate that NFLX’s operating margins are expected to expand to 22.0%, 24.0%, and 26.2%, for FY 2024, FY 2025, and FY 2026, respectively.
In my view, Netflix’s long-term forecast appears to be too optimistic. The substantial increase in Netflix’s operating profit margins in the long run are dependent on positive operating leverage driven by revenue and subscriber growth, and a more favorable revenue mix with the contribution of higher-margin advertising revenue.
But as I discussed in an earlier section of this article, I am not confident that NFLX’s initiatives relating to a new ad-supported tier and crackdown on shared logins will be successful based on an analysis of key metrics. In other words, I think that Netflix’s future revenue CAGR will be lower than +10%, and I don’t expect the company to deliver significant operating margin expansion above 20% in the long run.
Is NFLX Stock A Buy, Sell, or Hold?
NFLX is a Hold. I don’t expect negative surprises for Q2 2022, as expectations for the upcoming quarter are already low and Netflix’s valuations have de-rated to a large extent. According to S&P Capital IQ valuation data, NFLX’s consensus forward next twelve months’ normalized P/E multiple has compressed from its one-year peak of 40.7 times to 16.7 times now. On the flip side, I think that Netflix might not be able to live up to the market’s expectations with respect to revenue growth and operating profit margins in the long-term.
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