Stock of the Week: Netflix (23.10.2024)

Netflix just delivered another impressive quarter, marking significant growth in both subscribers and profitability. The streaming giant continues to demonstrate its market leadership with successful expansion into advertising and live content, while maintaining strong engagement levels of approximately two hours per member per day. With the stock reaching all-time highs, Netflix's evolution from a pure streaming service to a diversified entertainment platform is proving successful.

Q3 2024 Results vs Estimates:

• Revenue: $9.82 billion (+15% YoY) vs estimate $9.78 billion
• Operating Margin: 29.6% (up from 22.4% YoY) vs estimate 27.8%
• Operating Income: $2.91 billion (+52% YoY) vs estimate $2.72 billion
• EPS: $5.40 (+44.8% YoY) vs estimate $5.12
• Free Cash Flow: $2.19 billion (+15.9% YoY) vs estimate $1.73 billion
• Global Paid Memberships: 282.72 million (+14.4% YoY) vs estimate 281.92 million
• Net Paid Additions: 5.07 million (-42% YoY) vs estimate 4.52 million
  • UCAN: +690,000 (-61% YoY) vs estimate +696,658
  • EMEA: +2.17 million (-45% YoY) vs estimate +1.44 million
  • LATAM: -70,000 (vs +1.18M YoY) vs estimate +975,270
  • APAC: +2.28 million (+21% YoY) vs estimate +1.56 million
• Ad-Supported Tier: 35% QoQ growth, >50% of new sign-ups (no estimate provided)

Q4 2024 Guidance:

• Revenue: $10.13 billion vs estimate $10.05 billion
• Operating Margin: 22% vs estimate 21.2%
• EPS: $4.23 vs estimate $3.90
• Paid Net Adds: Expected higher than Q3 

Full Year 2024 Updated Guidance:

• Revenue Growth: 15% (high end of previous 14-15% range)
• Operating Margin: 27% (raised from 26% previously)
• Free Cash Flow: $6.0-6.5 billion (raised from about $6.0 billion)

2025 Initial Guidance:

• Revenue Target: $43-44 billion (11-13% growth)
• Operating Margin Target: 28%
• Ad Revenue: Expected to double (from small base)
• Paid Membership: Healthy increase expected (no specific target provided)

Core Business Evolution 

Netflix's transformation extends beyond its traditional streaming model. The company has successfully implemented several strategic initiatives that are reshaping its business landscape. The ad-supported tier has become a significant growth driver, demonstrating strong adoption with 35% quarter-over-quarter membership growth. This lower-priced option is proving attractive to both new subscribers and existing users, while maintaining similar engagement levels to ad-free tiers. Password sharing monetization has transitioned from a challenge to a revenue opportunity. The company's approach has effectively converted shared accounts into paid memberships while maintaining user satisfaction. Live content expansion represents a new frontier, with upcoming NFL games, the Tyson vs. Paul boxing match, and WWE programming starting January 2025. This move into live entertainment diversifies content offerings and creates new advertising opportunities.

Financial Performance & Outlook 

Netflix's financial metrics show strong momentum across key areas. Revenue growth remains robust at 15% year-over-year, driven by subscriber growth and effective monetization strategies. The company's guidance for 2025 suggests continued confidence in maintaining double-digit growth. Margin expansion has been particularly impressive, with operating margins reaching 29.6% in Q3 2024. This demonstrates Netflix's ability to scale efficiently while investing in new initiatives. Free cash flow generation continues to strengthen, reaching $2.19 billion in Q3 2024, providing flexibility for content investment and strategic initiatives.

Content Strategy 

Content remains at the core of Netflix's success, with several key elements. Original Programming continues to drive engagement, with a strong slate including new seasons of popular series and innovative new content. Regional Content Development targets specific market needs, particularly in high-growth areas like APAC and EMEA. Live Programming expansion creates new opportunities for user engagement and advertising revenue.

Growth Initiatives and Strategic Development

Netflix's growth strategy encompasses three main vectors that position the company for continued expansion. In advertising, the company is taking a methodical approach by prioritizing subscriber scale before maximizing monetization. The ad-supported tier shows promising engagement metrics, with users demonstrating similar viewing patterns to those on ad-free plans. This validates the company's strategy as it prepares for broader ad tech platform deployment in 2025. International markets remain a crucial growth engine, with particularly strong performance in APAC and EMEA regions. Netflix has refined its approach to each market through carefully calibrated pricing strategies and investment in local content production. This localization strategy has proven effective in driving adoption while maintaining profitability across diverse markets. The company's entry into live entertainment marks a significant evolution of its content strategy. The upcoming slate includes high-profile sports events, notably NFL games and boxing matches, culminating in the launch of weekly WWE programming in 2025. This expansion into live content creates new opportunities for audience engagement and advertising revenue.

Market Position and Competitive Advantages

Netflix's market leadership is built on substantial scale advantages. With 282.72 million global paid memberships, the company benefits from unmatched user data and content distribution efficiency. This scale supports an extensive content library and enables continued investment in advanced technology infrastructure, creating significant barriers to entry for competitors.

The company's competitive differentiation stems from three key elements. First, its original content pipeline continues to deliver compelling programming that drives engagement. Second, the successful implementation of advertising has opened new revenue streams while maintaining user satisfaction. Third, the expansion into live content creates additional differentiation from traditional streaming competitors.

Risk Factors and Challenges

Operational challenges present several key risks. The technical complexity of live streaming at scale requires significant infrastructure investment and carries execution risk. Content production remains subject to cost inflation and production uncertainties. International operations expose the company to currency fluctuations that can impact reported results.

Market-related risks center on valuation and competition. Current valuation multiples reflect high growth expectations that must be met to justify premium pricing. Competitive pressures continue from both traditional media companies and new entrants. The advertising business, while promising, remains in early stages and faces execution uncertainty.

Future Growth Trajectory

Near-term catalysts provide visibility into growth potential. The December NFL games on Christmas Day represent a significant test of live sports capabilities. The Tyson vs. Paul boxing match offers the opportunity to demonstrate large-scale live event handling. WWE's weekly programming starting January 2025 will provide recurring live content that could drive sustained engagement.

Looking further ahead, several long-term growth drivers support Netflix's expansion plans. The advertising business is positioned for revenue acceleration as infrastructure and scale improve. International markets offer continued penetration opportunities, particularly in developing regions. Live content capabilities open new entertainment categories, while gaming initiatives provide additional engagement vectors.

The company's confidence in these growth initiatives is reflected in its 2025 guidance of $43-44 billion in revenue and 28% operating margin. This forecast suggests Netflix can maintain robust growth while expanding profitability, though execution across multiple initiatives will be crucial to achieving these targets. The combination of clear near-term catalysts and established long-term drivers provides multiple paths to sustained growth, even as the streaming industry continues to evolve.

Valuation

We decided to base our assumptions on historical averages and company forecasts. We have assumed a 15% revenue growth and 27% operating margin for the 5 years of forecasts. Decision to make 5 years of detailed forecasts rather than 10 years was made due to huge uncertainty over whether the company's robust growth rates will last. Other assumptions were based on 5-year averages. 

As terminal value tends to account for a significant part of DCF valuation, especially with shorter periods of detailed forecasts, we have decided to take a very conservative approach here. For the terminal value calculations we have used a 6% revenue growth as well as 10.5% terminal WACC, down from 11% WACC used for 5 years of forecasts to capture the effect of sector growth. Also the assumption of high terminal revenue growth is based on the outlook that the sector will be able to sustain high growth in the future, as customer base and needs evolve.

Such a set of assumptions provides us with an intrinsic value of $735.74 per share which showcases a downside of 3.7% to current market price. 

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions. 

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Next, let's take a look at how Netflix compares with peers. We have constructed a peer group consisting of 4 companies, whose business model might be similar to Netflix: Walt Disney, Paramount Global, Fox Corp and Spotify. As can be seen Netflix is above the mean for the peers in every aspect. We have calculated Netflix mean, median as well as cap-weighted multiples for the peer group. Three different Netflix valuations for each of those multiples were later calculated. As one can see in the table below, the vast majority of those suggest that Netflix shares are overvalued at current prices, with some valuation metrics being disturbed by high Spotify data. However Spotify's business model is similar to Netflix.

Source: Bloomberg Finance LP, XTB Research

Recommendations: Netflix has 63 recommendations, with 43 "buy" and highest price of $925, 17 “hold” and 3 “sell” with lowest price of $550. The 12-month average stock price forecast is $768.11, implying a 0.5% upside potential from the current price.

Technical analysis: 

Netflix stock is trading above its 15- and 30-day SMAs for the third consecutive day, following better-than-expected earnings. The key support level is set at the previous high of $735.25, which also aligns with a discounted cash flow (DCF) valuation estimate. If this support is broken, the stock could quickly retest moving averages down to the 50-day SMA at $700.18.

For bulls, a small pullback would help cool off the elevated RSI levels, which, along with MACD, still shows bullish divergence and the potential for further upside momentum.

Source: xStation