Netflix (NASDAQ: NFLX) earnings surprised to the upside in Q3 2021, but shareholders were in for a sharp shock as Q4 earnings came to light. Three weeks into 2022, the NFLX share price has crashed over 33%. Is it now time to buy the dip?
What is Netflix?
Netflix is a streaming entertainment giant. The company has seen spectacular growth over the past 25 years since it emerged from sending DVDs by mail to become the independent production company and household name we know today.
Nowadays, individuals and families are committed to paying the monthly Netflix subscription to access its bank of popular movies and TV episodes. This growing content library is an amalgamation of Netflix Originals and distribution deals.
Netflix was founded by Reed Hastings and Marc Randolph in 1997.
How does Netflix make money?
Netflix makes money from three segments: Domestic Streaming, International Streaming and Domestic DVD.
Its Domestic Streaming segment is the part we're most familiar with. Here Netflix makes money from its monthly membership fees for streaming content. The International Streaming segment works in the same way, bringing revenues in from overseas.
Meanwhile, it still operates a Domestic DVD segment bringing in money from DVD-by-mail. This part of the business is a watered-down version of its former self, now offering around 4,000 titles from a library that once contained over 100,000 titles.
It's also beginning to branch into merchandising. On the back of Squid Game's success, it's selling tracksuits and other merch. Its Netflix shop also sells consumer products themed with the Witcher, Queer Eye, Stranger Things and many more.
It also plans on branching into the gaming market.
Financial and Metrics:
In 2021, Netflix achieved some significant milestones. Squid Game was the biggest TV show of the year, while Red Notice and Don't Look Up were two of the biggest film releases of all time. Meanwhile, Netflix was the most Emmy-winning and most-nominated TV network and the most Oscar-winning and nominated movie studio of 2021.
Throughout 2021, the company grew full-year revenue 19% year-over-year to $30bn. Operating income rose 35% year-over-year to $6.2bn, and Q4 ended with 222 million paid memberships.
A slew of popular shows led it to continue its streak in raising subscriber numbers quarter-over-quarter, along with monthly revenue per user by Q3. It also beat analyst estimates in earnings per share (EPS). Unfortunately, this growth slowed in Q4 2021.
In Q4, the business showed a decrease in churn, strong retention and viewing was up. It also beat earnings per share predictions by $0.50. But it didn't grow acquisition as fast as forecast, and operating margins fell to 8.2%, from 23.5% in Q3 and 14.4% year-over-year.
It expected free cash flow to run at a loss of around -$512m, but this came in at -$569m.
Netflix currently has a forward price-to-earnings ratio (P/E) of 11, which is reasonable and far below its average of 33. Its price-to-sales ratio (P/S) is 1.4, which is also low. Its market cap is now around $176bn.
However, guidance for Q1 2022 came in lower than expected, further disappointing investor outlook and hitting its share price hard.
Anticipating 2.5 million paid net additions in Q1 comes far below analyst expectations of 5.8 million. It also suggests a lower acquisition pace than pre-COVID levels. Overall, Netflix is targeting an operating margin of 19%-20% in 2022.
The company prioritizes using cash to reinvest in its core business and fund new growth opportunities like gaming, followed by selective acquisitions. Finally, it intends to return value to shareholders via stock repurchases.
Netflix spends a fortune on its production arm. Producing Hollywood-quality movies with top movie stars in the line-up does not come cheap, and the company is heavily in debt ($15.5bn). But it does see free cash flow turning positive this year and is focused on reducing its debt pile.
Is Netflix a good investment?
Netflix has steadily grown its sales year-over-year for the past decade. And during this time, its share price has soared, providing excellent shareholder returns.
The company is dedicated to growing its content library to include timeless classics and impressive IP. It recently acquired the Roald Dahl Story Company.
Some of Netflix's best performers include Lost In Space, Cocomelon and its Christmas movie catalog in recent weeks.
It's also branching out into producing Netflix Originals content in far-flung jurisdictions. This includes India, Turkey, Russia, Argentina, Mexico, Korea, Sweden and Denmark. It also subtitles foreign content for English-speaking audiences and vice versa.
What are the risks of investing in Netflix?
Despite producing award-winning shows, margins are expected to be squeezed as operational costs rise. Furthermore, competition is also a viable concern with the rise of HBO Max, Disney+, Apple TV, Hulu and Amazon Prime.
Nielsen's latest figures show Netflix maintains many key spots for total minutes viewed and original series, but Disney+ and Amazon are also making their presence known.
According to intelligence estimates from S&P Global Market Intelligence, Netflix's 2021 amortized content spend will amount to $13.6bn, rising to $18.9bn by 2025. Considering its debt levels, there is concern this is unsustainable.
In comparison, Disney plans to spend around $33bn in 2022. Of course, Disney is a much bigger company with more income streams and historical IP.
A controversial suggestion is that what Netflix classes as growth capital expenditure, should really be classed as operating CapEx. For if the company spends a fortune on producing something and it only helps keep subscribers engaged for a short window of time, this is an operating cost, not a long-term investment in the business.
While Netflix may be branching into gaming, this is a hugely competitive space that will not be easy to conquer.
Many broader risks could potentially affect the Netflix share price. These include a slowdown in attracting and retaining members, rising competition, producing engaging content, production risks, and disruptions caused by COVID-19.
How will inflation affect Netflix?
If prices are going up and consumers have less money to spend on treats, it's reasonable to assume a Netflix subscription could be among the first discretionary expenses to get the chop. However, many view Netflix as an affordable form of entertainment over the more expensive out-of-home alternatives. Therefore, it might just benefit from consumer cost-cutting.
Of course, inflation will also eat into its bottom line as production costs rise along with labor and licensing costs.
The US government is expected to raise interest rates to combat inflation over the coming months. This reduces analyst expectations on future profits.
Furthermore, a high US dollar value can lead to a loss of earnings in foreign exchange transactions. For instance, around 60% of its revenue comes from outside the US. The result of a strong US dollar the past six months has cost Netflix roughly $1bn in expected 2022 revenue.
Is Netflix stock a buy?
The world around us continues to battle multiple COVID variants, inflation, and many external headwinds. And now it seems the market is less convinced of Netflix's ability to continue its winning streak. Indeed, it's been underperforming most of its FAANG stock peers for weeks now.
While it looks a strong company with a broad reach at a glance, it may have reached the peak of its ascent. Its latest earnings release shows a massive subscriber miss, which is no minor issue. Plus, it raised subscription prices in the US, where competition from heavy hitters like Disney and Amazon is rife.
After a big run-up between August and November, the NFLX share price has sharply declined. It's now down 43% from its 52-week high.
Netflix is not about to disappear, but it seems a challenging pace of growth lies ahead; Therefore, its share price may see further downward pressure in the coming months.
Nevertheless, executive sentiment remains upbeat:
“Even in a world of uncertainty and increasing competition, we’re optimistic about our long-term growth prospects as streaming supplants linear entertainment around the world.”
As the entire market is down, there's a good chance Netflix will see its share price bounce but timing that will be tricky, and volatility is likely. NFLX stock does not offer shareholders a dividend to ease the pain, but it has been known to buy back shares, and any acquisition news could lead to a share price rebound.
