As one of the pre-eminent growth plays on the NASDAQ exchange, Netflix (NFLX) has long been included in the “FAANG” grouping of superstar growth stocks that have absolutely skyrocketed over the past decade. Indeed, it’s difficult to argue with the historical performance of Netflix. The company has been better than a 5-bagger for investors over the past five years. Those who have simply bought this stock and forgotten about it have done very well for themselves in the past.
The company’s business model has continued to be cheered by the market. Indeed, high levels of spending on content have resulted in continued subscriber growth and top-line growth that’s hard to ignore.
That said, from a bottom-line perspective, Netflix leaves many investors wanting. Let’s dive into why this stock may see some outsized downside, should rising inflation concerns and higher interest rates take growth stocks on a rough ride in the coming quarters.
Financials Look Better than Ever, But Are These Numbers Sustainable?
Looking at Netflix’s fundamentals, the long-term historical performance of this company’s overall business hasn’t really been great.
Netflix’s business model relies a great deal on heavy content spending to drive subscriber growth. Accordingly, Netflix has been burning a lot of cash to grow, something that has required the company to take on large sums of debt.
In fact, from 2016 to 2019, Netflix’s debt issuances increased rapidly each and every year. The company went from issuing $1 billion in debt in 2016 to nearly $4.5 billion in 2019. Then the pandemic happened.
This past year, Netflix had to raise "only" $1 billion in debt. In other words, its spending dropped back down to 2016 levels.
Part of this was due to higher revenues spurred by increased demand for in-home entertainment, brought about as a direct result of the pandemic. Some of this was due to content production slowing during the pandemic. Whatever the reason, the corresponding improvement in Netflix’s unit economics as a result of the pandemic pushed the company into positive cash flow territory.
Indeed, from this perspective, things look decent for investors in NFLX stock. In 2020, the company posted its first positive year in terms of free cash flow since 2011. Approximately $4.38 in free cash flow was generated per share in 2020. In trailing 12 month terms, the number is $5.57.
Accordingly, many investors in NFLX stock may be emboldened by this fact. After all, the value of any stock is directly related to the discounted future free cash flows a given company generates. The fact that Netflix is now in the black in this key metric ought to make this stock an easier one to forecast.
Not so fast.
Many investors are of the view that the recent free cash flow performance of Netflix is temporary. There are a couple of factors driving this view.
First, Netflix’s recent subscriber growth this past quarter fell way short of the company’s own estimates, as well as consensus analyst estimates. Netflix posted gains of only 4 million new subscribers in the first quarter, well-short of the company’s guidance of 6 million new subscribers, and the consensus estimates of 6.3 million. Thus, there’s a lot of credence being given to the idea that the pandemic provided a one-time boost to free cash flow that may be unsustainable.
The second annoying fact investors will need to consider is that as the economy reopens, film studios and content producers will once again kick it into high gear to make up for lost time. With many film crews shut down for a good portion of this past year, ramping up production on Netflix’s end will undoubtedly result in more capital spending. Accordingly, many investors expect Netflix to return to the bond markets in a big way this coming year, pushing down free cash flows into negative territory once again.
Additionally, even basing Netflix’s valuation on its trailing 12-month free cash flow numbers, this is a stock that’s trading at roughly 90-times free cash flow. That’s insanely expensive. Even if one were to consider the idea that these free cash flow numbers could potentially be sustained (which may believe is highly unlikely due to the one-time boost the pandemic provided), Netflix is expensive. If cash flows fall back to earth in the coming quarters, there’s no telling how steep of a correction investors in NFLX stock could see.
What Analysts Are Saying About NFLX Stock
According to TipRanks’ analyst rating consensus, NFLX stock comes in as a Moderate Buy. Out of 35 analyst ratings, there are 26 Buy recommendations, 6 Hold recommendations, and 3 Sell recommendations.
As for price targets, the average Netflix analyst price target is $611.27. Analyst price targets range from a low of $342.00 per share to a high of $720.00 per share.
Bottom Line
From a fundamentals perspective, Netflix appears to be the most richly-valued FAANG stock on the market right now. Accordingly, those concerned about headwinds for growth stocks may want to direct their attention toward any of the other FAANG names presently.
The view that Netflix’s recent outperformance is a one-time event appears to have taken hold in the market. This stock has traded within a relatively narrow band for the better part of the past year. In a best-case scenario, that’s where this stock is likely to trade for some time.
Disclosure: Chris MacDonald held no position in any of the stocks mentioned in this article at the time of publication.
Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.
From next month, Apple (AAPL) will stop offering free Apple TV+ trials for extended periods to customers who purchase its other products, according to a CNBC report.
Apple TV+ is a video streaming service that competes with Netflix (NFLX) and Disney+ (DIS). It costs $4.99 per month but can be purchased as a bundled package with services like iCloud and Apple Music for $14.95 per month.
The company previously offered a free one-year Apple TV+ subscription to customers who purchased any of its devices, such as the iPhone or Apple Watch. That free offer is about to end. Starting July 1, customers will only get three months of free service when they buy an Apple device, according to the report.
At the same time, customers who have enjoyed the one-year free trial will start to be automatically billed. The end of the long Apple TV+ free trial comes as the second season of the hit comedy, Ted Lasso, is set to premiere on July 23. New seasons of other popular shows are also expected in the coming months. (See Apple stock chart on TipRanks).
Credit Suisse analyst Matthew Cabral recently reiterated a Hold rating with a price target of $150 on Apple stock. Cabral’s price target suggests 12.69% upside potential.
According to the analyst, Apple’s 2021 annual developer event dubbed WWDC was "largely as expected". Cabral highlighted Apple’s commitment to privacy and data protection and advantage in on-device processing. Additionally, Cabral stated that the focus remains on iPhone strength going into the second year of 5G.
Consensus among analysts is a Moderate Buy based on 20 Buys, 5 Holds, and 2 Sells. The average Apple analyst price target of $157.92 implies 18.64% upside potential to current levels.
AAPL scores a “Perfect 10” on TipRanks’ Smart Score rating system, indicating that the stock has strong potential to outperform market expectations.
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There is a point at which a company is no longer growing at a torrid clip yet is still expected to grow at a more leisurely pace. When a company reaches such a point, it is time to view it in a different light. For Wells Fargo’s Steven Cahall, Netflix (NFLX) has now reached that stage.
“We see NFLX transitioning from Growth to GARP (growth at a reasonable price) as the stock sheds its net add past and re-emerges as an earnings growth company,” the analyst said. “We think bottom-line performance is becoming steady enough that the company could even provide longer-term EPS growth guidance.”
Until recently, as is common for growth-minded companies, Cahall says NFLX's EPS “were immaterial.”
However, like it has done in so many areas, Covid-19 has changed Netflix – mainly due to the “2020 pull-forward of subscribers.” NFLX is no longer “primarily a subscriber story,” says Cahall, but an entity less surprising and more palatable for GARP investors. Which also means that the single most important KPI (key performance indicator)—streaming net adds— is of less importance.
Basically, what Cahall is saying is that there’s a limit to the speed at which Netflix can grow its subscriber count.
“Even if net adds hold steady in the 20-25mm per annum range from here, the math makes annual net adds a decelerating percentage on the growing base,” Cahall explained. “Quarterly net adds are an even less helpful indicator of long-term bottom-line performance on 200-250mm subscribers.”
Not that adding new subs isn’t important, it’s just that Netflix’ model is now “far more multifaceted,” one in which pricing is becoming a “bigger piece of the financial puzzle.”
For example, while streaming revenue growth over the past 5 years was made up of 79%/21% between subs and price, over the next 5 years, Cahall anticipates this will change to 67%/33%.
Summing up, Cahall says he “likes the current entry point,” reiterating an Overweight (i.e. Buy) rating for the stock, along with a $700 price target. Should his thesis play out, a twelve-month gain of ~35% could potentially be in the cards. (To watch Cahall’s track record, click here)
So, that’s Wells Fargo’s view, what does the rest of the Street have in mind for Netflix? Out of 34 recent reviews, 25 are to Buy, 6 to Hold and 3 suggest to Sell, all culminating in a Moderate Buy consensus rating. The average price target stands at $611.27, indicating potential 12-month gains of 18%. (See Netflix stock analysis on TipRanks)
To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.
Disclaimer: The opinions expressed in this article are solely those of the featured analyst. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.