Stock of the week - Netflix (18.07.2024)

• Netflix to report Q2 earnings today
• Company expected to see revenue growth accelerate and margins improve
• Net income expected to increase 40%
• Weakish new subscriber additions expected
• A look at valuation
• A look at the chart

Netflix (NFLX.US) will report earnings for the second quarter of 2024 today after close of the Wall Street session. Recent earnings release from the company triggered big share price moves, and options markets price in similarly big move this time. What to expect from the release? Let's take a look at the upcoming release, what to focus on, and how Netflix valuation looks like.

Netflix reports earnings today after market close!

Netflix is scheduled to report its Q2 2024 earnings report today after close of the Wall Street session. Analysts' expectations point to an acceleration in sales growth as well as big improvement in margins. Revenue growth is expected to accelerate to above 16% YoY from 14.8% YoY in Q1 2024, with company expected to report a 14.9% YoY jump in total subscribers. However, an expected 4.9 million additions of new subscribers would be an almost two times smaller than addition reported in Q1 2024. Thanks to quick revenue growth and improve cost efficiency, Netflix is expected to report a 40% year-over-year jump in net income. However, average revenue per user growth is expected to be positive only in US & Canada, with EMEA expected to see flat revenue per user, and declines being expected in Latin America and Asia Pacific.

Q2 2024 earnings expectations

• Revenue: $9.53 billion (+16.3% YoY)
  • US & Canada: $4.28 billion (+18.8% YoY)
  • Europe, Middle East & Africa: $3.00 billion (+17.2% YoY)
  • Latin America: $1.18 billion (+9.4% YoY)
  • Asia Pacific: $1.04 billion (+13.5% YoY)
• Net new subscriber additions: +4.87 million (-17.4% YoY)
  • US & Canada: +1.19 million (+1.5% YoY)
  • Europe, Middle East & Africa: +1.56 million (-35.7% YoY)
  • Latin America: +0.96 million (-21.5% YoY)
  • Asia Pacific: +1.25 million (+17.3% YoY)
• Total subscribers: 273.78 million (+14.9% YoY)
  • US & Canada: 84.76 million (+12.2% YoY)
  • Europe, Middle East & Africa: 92.88 million (+16.4% YoY)
  • Latin America: 48.56 million (+14.4% YoY)
  • Asia Pacific: 48.75 million (+20.2% YoY)
• Average revenue per user: $11.70 (+1.3% YoY)
  • US & Canada: $17.19 (+7.5% YoY)
  • Europe, Middle East & Africa: $10.08 (+0.1% YoY)
  • Latin America: $8.13 (-5.3% YoY)
  • Asia Pacific: $7.41 (-3.3% YoY)
• Cost of revenue: $5.16 billion (+10.5% YoY)
• Gross profit: $4.35 billion (+23.9% YoY)
  • Gross margin: 45.8% vs 42.9% a year ago
• Operating expenses: $1.85 billion (+9.6% YoY)
• Operating income: $2.54 billion (+39.0% YoY)
  • Operating margin: 26.5% vs 22.3% a year ago
• Net income: $2.08 billion (+40.0% YoY)
  • Net margin: 20.2% vs 18.2% a year ago
• EPS: $4.84 vs $3.35 a year ago
• Adjusted EPS: $4.74 vs $3.29 a year ago
• Capital expenditures: $109 million (+8% YoY)
• Free cash flow: $1.61 billion (+20.0% YoY)

Netflix is expected to report negative growth in revenue per user for Asia Pacific and Latin America, as well as flat growth in EMEA. Dotted lines on the chart mark Q2 2024 forecasts. Source: Bloomberg Finance LP, XTB Research

Subscriber numbers in focus

As it is usually the case with Netflix, it will not be headline results that attract the most attention but rather subscriber numbers. As we have already mentioned, company is expected to report a new subscriber addition around two times smaller than in Q1 2024. If expectations are met, the sub-5 million addition would mark the smallest addition since Q2 2023 and would also be weaker than 5-year average of around 5.7 million.

A point to note is that Netflix has already announced that it will stop publishing subscriber numbers starting from 2025. Such an announcement has immediately spark concerns that company may be anticipating slowdown in subscriber growth as otherwise there would be no incentive to halt publications. This could be a leading theme during the earnings release, especially if company fails to deliver onto market expectations and report a weakish additions.

Source: Bloomberg Finance LP, XTB Research

Previous earnings releases triggered big share price moves

Netflix earnings releases tend to trigger large reaction in the market. Market reactions to the previous 20 quarterly release have been presented in the table below. As one can see, there no always was a clear connections between beats/misses in sales, earnings and subscribers, and market's reaction. Netflix post big beats in earnings and subscribers in Q1 2024, but stock plunged over 9% during the post-earnings session as company announced it will stop publishing subscriber data.

Average absolute market reaction during the post-earnings session for the past 20 quarters is 9.8%. A volatility implied by the options markets suggests a possibility of an around-9% move in the share price on the day following earnings release. Having said that, markets are expecting Netflix shares to be similarly volatile tomorrow as they were during recent earnings releases.

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 assume a 15% revenue growth and a 25% operating margin for the 5 years of detailed forecasts, and based remaining variables on 5-year averages. Terminal value assumptions being set as follows - 6% terminal revenue growth and 9% terminal weighted cost of capital (WACC).

Such a set of assumptions provides us with an intrinsic value of Netflix shares of $761.96 - over 17% above yesterday's closing price. However, terminal value forecast accounts for around 88% 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 5 companies - Walt Disney, Paramount Global, Warner Bros Discovery, Comcast and Fox Corp. We have taken a look at a numebr of different valuation multiples, including trailing and forward multiples.

As one can see in the table below, Netflix looks to be significantly overvalued compared to peers. Company trades at much higher multiples than its peers. This can be blamed on recent strong gains in share price as well as at company still being considered a 'high growth' unlike its peers. We have calculated mean, median and cap-weighted multiples for the group and used them to value Netflix. As one can see in the table below, in case of each multiple analyzed, all 3 means turned out to be much lower than multiples for Netflix. Even the highest valuation - mean forward P/E valuation of $396.03 per share - is almost 40% lower than yesterday's cash closing price.

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Taking a look at Netflix (NFLX.US) chart at weekly interval (W1), we can see that the stock has rallied significantly since the April 2024 low, which was reached after release of Q1 2024 earnings. Stock has jumped almost 30%, but the rally was halted by the resistance zone ranging below $700, near all-time highs reached in late-2021. Should launched a pullback. Should the correction match the range of the largest correction in the ongoing upward impulse, it would mean dropping to around $560 per share area. This would require a drop of over 13% from current levels. Unless we see a break below the $560 area, the main trend should remain upward.

Netflix chart at W1 interval with option implied post-earnings reaction range. Source: xStation5