Stock of the week - Netflix (18.04.2024)

• Netflix to report Q1 2024 earnings today after market close
• Market expects uptick in revenue growth
• Net income expected to grow over 50% YoY
• New subscriber additions to slow after blockbuster Q4 2023
• Investors will focus on subscriber data, revenue trends and profitability
• A look at valuation
• Stock seems locked in short-term $605-635 range

Netflix (NFLX.US) is trading over 25% higher year-to-date, outpacing gains made by broader market indices like S&P 500 or Nasdaq. A big test for the rally is approaching as the company is set to announce its Q1 2024 results today after Wall Street session close. Earnings report for the previous quarter (Q4 2023) triggered an over-10% jump in share price, but will it be the same this time? Let's take a quick look at what market expects from Netflix report, what to focus on and also how company's valuation looks like!

Netflix to report Q1 2024 results

Netflix is scheduled to report Q1 2024 results today after close of the Wall Street session. The latest quarterly report from the company (Q4 2023) was a blockbuster, showing a massive over-13 million addition of new subscribers. Large and much better than expected subscriber addition pushed the stock over 10% higher during the post-earnings session, even in spite of Netflix missing earnings estimates.

Having said that, headline results (EPS and sales) may not be a key driver of market's reaction. Revenue trends, subscriber data and margins will be key factors to watch in Netflix' Q1 report. Outlook for Q2 2024 will also be watched closely. 

Markets are expecting a post-earnings volatility spike with options market implying an over-7% post-earnings move in Netflix shares, one of the biggest implied post-earnings moves among all of this week's earnings reporters.

Q1 2024 earnings expectations

• Revenue: $9.26 billion (+13.5%)
  • US & Canada: $4.09 billion
  • Europe, Middle East & Africa: $2.96 billion
  • Latin America: $1.17 billion
  • Asia Pacific: $1.04 billion
• Net new subscriber additions: 4.84 million (+176% YoY)
  • US & Canada: 0.98 million (+855.9% YoY)
  • Europe, Middle East & Africa: 1.58 million (+145% YoY)
  • Latin America: 0.83 million (+283.5% YoY)
  • Asia Pacific: 1.49 million (+2.3% YoY)
• Total subscribers: 264.52 million  (13.8% YoY)
  • US & Canada: 82.17 million (+10.5% YoY)
  • Europe, Middle East & Africa: 89.45 million (+15.6% YoY)
  • Latin America: 46.79 million (+13.4% YoY)
  • Asia Pacific: 46.83 million (+18.6% YoY)
• Average revenue per user: $11.78 (+0.7% YoY)
  • US & Canada: $16.92 (+4.6% YoY)
  • Europe, Middle East & Africa: $11.07 (+1.7% YoY)
  • Latin America: $8.42 (-2.0% YoY)
  • Asia Pacific: $7.45 (-7.3% YoY)
• Cost of revenue: $5.08 billion (+5.8% YoY)
• Gross profit: $4.15 billion (+23.6% YoY)
  • Gross margin: 44.8% (41.1% a year ago)
• Operating expenses: $1.79 billion (+8.7% YoY)
• Operating income: $2.43 billion (+41.8% YoY)
  • Operating margin: 25.6% (21% a year ago)
• Net income: $1.99 billion (+52.5% YoY)
  • Net margin: 20.1% (16% a year ago)
• EPS: $4.59 (+56.5% YoY)
• Adjusted EPS: $4.52 (+56.9% YoY)
• Capital expenditures: $102.4 million (+65.1% YoY)
• Free cash flow: $1.88 billion (-11.1% YoY)

Netflix beats, misses and price reactions for the past 20 quarterly releases. Source: Bloomberg Finance LP, XTB Research

Subscriber numbers

As usual, subscriber numbers will be one of the most closely watched data in Netflix earnings release. Netflix surprised significantly in this case in Q4 2023, reporting an addition of over-13 million net new subscribers - the biggest jump since pandemic Q1 2020. Company did not provide a guidance for subscriber growth in Q1 2024, but median expectations among analysts surveyed by Bloomberg is for a 4.84 million increase to 264.52 million total subscribers. This would mark a 13.8% YoY growth and an acceleration from 12.8% YoY growth reported for Q4 2023. An acceleration in subscriber growth in 2023 was largely due to Netflix embarking on a password-sharing crackdown in May 2023.

Netflix is expected to report an acceleration in year-over-year growth in total subscribers. Source: Bloomberg Finance LP, XTB Research

While total number of subscribers is expected to reach another all-time high this quarter, net new subscriber addition are in fact expected to be low. A 4.84 million growth would be almost 3 times smaller than the addition reported in Q4 2023, and would also be below the average subscriber addition for recent years. However, those expectations are seen by some as somewhat conservative and a beat in subscriber data cannot be ruled out given strong momentum in the data and strong content slate.

While year-over-year total subscriber growth is expected to accelerate, expected net new subscriber addition in Q1 2024 is expected to be rather small, especially following a massive jump in Q4 2023. Source: Bloomberg Finance LP, XTB Research

Revenue trends

Netflix revenue growth has been slowing in recent years. However, growth looks to have bottom out in late-2022 and early-2023. A noticeable acceleration could be spotted in the second half of 2023 in revenue growth in all major regions, with revenue in EMEA growing the most. However, this acceleration in growth is expected to have stalled in Q1 2024. Total revenue growth is expected to tick slightly higher, with only US & Canada expected to see acceleration.

Netflix revenue growth rebounded in 2023 and solid pace of growth from Q4 2023 is expected to have lasted in Q1 2024, thanks to a stronger growth in US & Canada. Dotted lines represent expectations for Q1 2024. Source: Bloomberg Finance LP, XTB Research

The question now is how much of this growth comes from subscriber base expansion and how much comes from increased profitability. A look at average revenue per user growth data may help. This data looks even less rosy, with noticeable slowdowns in growth expected in EMEA, Latin America and Asia Pacific. Moreover, growth in Latin America and Asia Pacific is expected to turn negative this quarter.

Things look less rosy when it comes to average revenue per user growth. Latin America and Asia Pacific are expected to see year-over-year declines. Dotted lines represent expectation for Q1 2024. Source: Bloomberg Finance LP, XTB Research

Margins

Speaking about profitability, let's take a look at Netflix margin data. Data on Netflix gross, operating and net margins is presented on the chart below. As one can see, Netflix margins have been improving between 2016 and launch of Covid pandemic in 2020. However, this improvement has stalled later on and margins began to move sideways. A big jump in margins is expected in Q1 2024. However, a word of caution is needed. The first quarter of the year has been marked with seasonal peaks in margins, while the fourth quarter has often been marked with seasonal lows in data. Having said that, a jump in margins above recent range would be seen as a positive, but matching estimates may be seen a slight disappointment. 

Netflix margins have been moving sideways following the launch of the pandemic. While Q1 2024 margins are expected to improve considerably compared to Q4 2023, it should be noted that Q1 often sees seasonal peaks while Q4 often sees seasonal troughs in margin data. Dotted lines represent expectations for Q1 2024. Source: Bloomberg Finance LP, XTB Research

Outlook

Apart from Q1 2024 data itself, investors will also pay a close attention to guidance company will offer for the coming quarters. Netflix was very optimistic about 2024 during the Q4 2023 earnings presentation, and the question is whether this optimistic outlook materialized and is expected to last. Improvement in the company's fundamentals following the launch of Covid pandemic is evident, with Netflix no longer being a cash-burning company, but Q1 free cash flow expectations suggest that the company may report a drop in 4-quarter free cash flow for the first time since the turn of 2021 and 2022.

When it comes to Q1 2024 guidance, Netflix guided for $9.24 billion in revenue, $2.42 billion in operating profit, $1.98 billion in net income as well as adjusted EPS of $4.49. Current analysts' expectations slightly exceed company's guidance. 

Covid pandemic transformed Netflix from a cash-burning entity into a company that generates positive free cash flow. However, expectations for Q1 2024 (green colour) suggest that 4-quarter free cash flow will weaken compared to Q4 2023. Source: Bloomberg Finance LP, XTB Research

A look at valuation

Let's take a quick look at Netflix valuation with two often used valuation methods - DCF and multiples. As Netflix is not a dividend paying stock, it cannot be valued with Gordon Growth Model, which we often use in our Stock of the week analysis. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices.

DCF

Let's start with probably the most popular fundamental model for valuing stocks - Discounted Cash Flow method (DCF). This model relies on a number of assumptions. We have decided to take a simplified approach and base those assumptions around averages for the past 5-years. Detailed forecasts for 10 years were made, with terminal value assumptions being set as follows - 4% terminal revenue growth and 9.4% terminal weighted cost of capital (WACC). Such a set of assumptions provides us with an intrinsic value of Netflix shares of $678.90 - over 10% above yesterday's closing price. Terminal value forecast accounts for around 72% of DCF valuation.

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. A sensitivity matrix for different sets of Operating Margin and Revenue Growth assumptions have been provided below.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples

Next, we have decided to take a look at how Netflix valuation compares with its peers. We have constructed a peer consisting of 4 companies that are seen as rivals to Netflix - Walt Disney, Paramount Global, Warner Bros Discovery and Fox Corp. We have taken a look at 6 different valuation multiples - P/E, P/BV, P/S, P/FCF, EV/Sales and EV/EBITDA.

As one can see in the table below, Netflix valuation does not look rosy in comparison to its peers. Company trades at much higher multiples than its peers, as recent share price rally outpaced improvement in Netflix fundamentals. We have calculated mean, median and cap-weighted multiples for the group and used them to value Netflix. Trimmed average has been calculated (excluding the highest and the lowest valuation) for each group of multiples. Cap-weighted multiples provide us with the highest valuation - $246.47 per share. However, this is still almost 60% below yesterday's closing price!

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Last but not least, let's take a look at Netflix chart at D1 interval. Taking a look at the chart we can see that has been trading in a strong upward move for almost 2 years now. Stock jumped almost 300% since May 2022 lows. However, the advance was halted in the $640 swing area, marked with local highs and lows from late-2021. Stock has been trading mostly sideways in the $605-635 range over the past month or so, and it looks like analysts are waiting for the catalyst for the next big move. Q1 earnings release could be such a catalyst. Should the report surprise to the upside, with another quarter of very strong subscriber growth, another spike in share price may follow. In such a scenario, all-time highs in the $700 area that were reached in late-2021 will become the focus of the bulls.

Source: xStation5