This article was written by Vladimir Mazepa, a Financial Analyst at I Know First
Subscription Numbers will be important in the upcoming Netflix financial results on January 17, 2019. This report can give a boost for the entire year.
:SWOT Analysis Summary
The Boom In Subscription Numbers
In a company such as Netflix, one of the most important metrics to watch is the company’s subscriber numbers. There is a boom every quarter in new members. Netflix brought 6.7 million new subscribers in Q3 2018. It’s a 5.3% growth compared to the previous quarter and 25.5% to previous year quarter. These are very promising numbers.
It must be pointed out that now these figures include both paid memberships and free trials, but the from beginning 2019 Netflix will start to track paid memberships only, so the figures will be more precise and directly connected to revenue.
Tremendous International Expansion
While American markets have already been conquered by Netflix, the next step is to grow internationally. It is clearly seen that the figures for international subscribers are rising, Netflix is trying to spread worldwide and is doing it very well.
Netflix’s Advantage Over Amazon Prime
It must be pointed out that competition with Amazon Prime is getting more difficult, but Netflix is still a leader in the industry and beats Amazon Prime in market share and revenues every year. Moreover, people subscribe to Amazon Prime not only for watching videos, series, films but also for instance, for having free delivery and even with these numbers included, Netflix beats Prime (see the comparison on the chart below). If there is really a $5 billion increase in Netflix’s original content, a huge boost may be seen in revenue by the end of 2019.
Furthermore, I see that Netflix is the most powerful player worldwide with the biggest market share.
[Source: Amazon Annual Report, Netflix Annual Report]
Positive Operating Margin And Revenue
A positive increase in Operating Margin and Revenues is a good indicator of company growth since a greater portion of sales is translated into operating income and not wasted. Netflix’s revenue is going up every quarter and is 14.89 Billion for 3Q 2018. Operating Margin is 10.98% in 3Q 2018 and is rising, which is a decent percentage for the sector. The strategy of the company is to boost Revenues and Operating Margin and that’s why such a huge decline is being seen in FCF and at the same time an increase in profitability.
Bullish Analyst Recommendations For Netflix
The majority of analysts have a bullish outlook for Netflix. Of the 40 analysts, 24 recommend buying, 9 of these 24 rate Netflix as a strong buy. Only 14 analysts give Netflix a neutral rating.
According to the latest data, UBS upgraded Netflix from Neutral to Buy at a target $410. Goldman Sachs price target is $400. Raymond James upgraded its rating from Outperform to Strong Buy with a price target to $450.
Negative Free Cash Flow
According to the company’s statement, free cash flow in Q3 was -$859 million vs. -$465 million in the same quarter last year. Management anticipates FCF to be closer to -$3 billion than to -$4 billion for the full year in 2018. In addition, they expect quarterly FCF deficit to increase sequentially from Q3 to Q4 as our year to date FCF is -$1.7 billion.
The Company spends large sums of money to make original content and doesn’t look at Free Cash Flow. They clearly recognize this and it is a part of Netflix’s strategy:
“We recognize we are making huge cash investments in content, and we want to assure our investors that we have the same high confidence in the underlying economics as our cash investments in the past. These investments we see as very likely to help us to keep our revenue and operating profits growing for a very long time ahead”
Netflix Is Overvalued Among Its Peers
Looking at the chart, TTM P/E (Price to Earnings), Forward P/E and P/S (Price to Sales) ratios for Netflix and its competitors. Netflix has the second highest TTM P/E – 109.30, Forward P/E – 72.50 and the highest P/S – 9.42.
Historically, P/E of Netflix is quite low now and has been decreasing every quarter since March 2018 – from 198.2 until today’s approximately 110. Price to sales has also been decreasing since their peak in Q2 2018 of 12.67 and until today’s 9.68. The same decrease could be observed in Price/Book value, which is now 27.9.
Let’s look at the valuations before expenses. Netflix’s EV/EBIT (Enterprise Value to Earnings before Interests and Taxes) – 90.28 EV/EBITDA (Enterprise Value before Interests, Taxes, Depreciation, and Amortization) is 86.05, EV/REVENUES (Enterprise Value to Revenues) – 9.73.
The biggest threat comes from an Amazon. At the same time Amazon’s EV/EBIT – 72.18, EV/EBITDA – 31.29, EV/REVENUES – 3.64.
Time Warner Inc. (HBO): EV/EBIT – 11.49, EV/EBITDA – 4.58, EV/REVENUES – 2.42.
21st Century Fox (HULU PLUS): EV/EBIT – 17.72, EV/EBITDA – 16.07, EV/REVENUES – 3.38.
Looking at the ratios itself and among peers, Netflix is overvalued.
Netflix’s High Level of Debt
Netflix’s revenue by the end of for 3Q 2018 was $14.893 billion. To attract new customers, they have to create new content and for that purposes take new loans. Now Netflix has more than $8.3 billion in debt. And total liabilities are $18.17 billion. Netflix’s level of debt to net worth is very high – 166.4%. The level of debt to net worth has been increasing over the last five years 42.5% to 166.4%. Netflix obviously is taking more debt, and if it can not provide a good growth rate in the upcoming years, this level of debt and spending can harm the company.
Netflix spends huge sums of money on original programming and owns exclusive rights for them in documentaries, dramas, comedy series etc. In 2019 Netflix is planning to spend impressive $12-13 billion on original content, it is up to $5 more billion spending in 2019. New Netflix series may blow you away in 2019 and boost the stock price (such as Star Trek: Discovery season 2, Black Mirror season 5, Sex Education, The Witcher etc.)
Technology affects everyone and Netflix is taking advantage of it. In today’s life, people are watching shows in different formats like smartphones and tablets. Netflix is viewable on these devices, and moreover, it can offer good quality.
Netflix has partners all over the world and has more than 50 local partners in 25 countries. They are currently working with the BBC to deal with European laws and to be more conscious about this client base. They have partners in different directions: law, marketing, development. It’s perfect for the future of the company.
Bearish Market Can Drive NFLX Down
As you know the markets in the US are struggling because of the possible bear market, where a 19% decline could be observed on S&P 500, which consequently affected the price of Netflix. Almost all the macroeconomic indicators are showing slowing economic growth. In short-term I see the situation on S&P in range with ups and downs and big volatility. We are in the last economic cycle before the recession or even in the early recession. In the current market condition, the best way of investing is either reducing your current long positions or to find the companies with big opportunities to grow.
Here is the link for my article about S&P 500.
Rising Competition With Amazon Prime
It is clear that Amazon Prime is the most powerful rival but still cannot compete with Netflix. In my opinion, Netflix will not have any problems with challengers in 2019, because Netflix will provide good content for 2019.
Moreover, there is nothing to be worried about the most discussed series from Amazon Prime “Lord of the Rings”, as this will only debut in 2021 meaning that over 2019 Netflix is sure to remain an industry leader.
Why I Am Bullish On Netflix In 2019?
Even though the company has the major rival in the industry – Amazon Prime, it still cannot compete with Netflix, at least not in 2019. The fact that there is an economic slowdown, it means that the US now in a high volatility market and will see many upswings and downswings. In short, you do not have to expect Netflix to give major gains (according to Goldman Sachs and UBS target price is around $400-410).
Netflix is still a buy, the most important metrics: subscriber numbers, revenue, margin, earnings are growing rapidly. Overall, it has many strengths and opportunities, which far outweigh weaknesses and threats. It doesn’t matter now what is happening with free cash flow and debt, because Netflix is doing what is called a “scale up”, it is expanding the business, investing in an original content and, in that way, growing, trying to conquer not only the US but also the European market, where Netflix is not as popular yet.
You might think that Netflix is going to finish cash burn. No, in the letter to shareholders Netflix justifies its strategy and why they don’t look at negative figures. They are in the last phase, where the management of the company spends huge amounts of money to generate more profits in the future and this works well: revenue, subscriber numbers, and operating margin are growing. Generated profit will burst FCF and as soon as the company will be huge, I think, no sooner than by 2022 (According to Morgan Stanley) and 2023 (According to Moody’s), there could possibly be a change in the strategy for generating positive cash flows.
Moreover, Netflix expects free cash flow to turn positive in the future, but due to the fact that revenue is surging, they see an opportunity in such a high spending, and the company wants to raise spending on original content from $ 8 to $ 12-13 billion in 2019 and expects next year’s negative FCF as roughly flat with this year.
If they change their strategy at the right time, it will boost the stock price. The similar situation happened to Amazon before The Dotcom crisis when they didn’t generate cash, they then changed their strategy on time and now it is the largest company in the whole world. All in all, if there are no obstacles amid Netflix’s rivals, it is the right time to buy at a lower price.
In addition, Netflix subscribers are increasing very fast (It’s a 5.3% growth compared to the previous quarter and 25.5% to previous year quarter with 137 million subscribers worldwide). It means that the company is now a “brand”, it is popular among people and they like it for the exclusive content provided by the company.
Bullish Forecast I Know First For 2019
The I Know First machine learning algorithm has already made a forecast on 01 January 2019 with a positive outlook for Netflix over all time horizons. I Know First forecast is the most bullish for the 1-year period with a strong signal of 776.46 and predictability indicator of 0.69.
Past I Know First Success With NFLX Stock
On May 24, 2017, I Know First has made an accurate bullish Netflix stock forecast for one year. I Know First AI Algorithm issued a bullish 1year forecast for NFLS with a signal of 185.88 and predictability of 0.39. NFLX gained 112.67 % in 1 year in accordance with the bullish forecast.
It was discussed in the article, why Netflix is a buy and that Hollywood giants like Disney and Warner Bros are outdated. In addition, Netflix spent $6 billion on original content, which was the new dream for actors, cinematographers, videographers, screenwriters, directors, and creative artists. The 94 million subscribers required Netflix to continuously invest in new programming. Moreover, it took $9.99/month just to watch their Hollywood idols, fans gladly paid for it.