Netflix Stock: 5 Things That Smart Investors Should Know

Summary:

• Netflix posted an earnings beat in the fourth quarter of 2022 as the company saw positive subscriber trends and improving margins following slower hiring.
• The subscriber trends have been improving and surpassed expectations in the quarter, resulting in positive sentiment for the stock as the trend seems to have reversed.
• Reed Hastings stepped down as CEO in the quarter, while Ted Sarandos will be co-CEO with Greg Peters to guide Netflix forward.
• Management shared the progress on paid sharing and ad tier plan ramp up.
• Positive long-term commentary on Netflix’s ad business, which is expected to surpass Hulu’s ad business and make up 10% of total mix in the long run.

This article was first posted in Outperforming the Market.

In July 2022, I made the call that the bottom for Netflix (NASDAQ:NFLX) is in.

To date, Netflix has generated 62% returns for investors.

Since then, with each review of Netflix in October and December, I found the company’s fundamentals to have improved.

With the recent release of the fourth quarter 2022 results, this article will cover the five things that I feel that smart investors should know about Netflix.

5 things smart investors should know about Netflix

These are the five things that smart investors should know:

1. Earnings beat expectations as the business fundamentals are improving
2. Subscriber metrics surpassed expectations
3. CEO Reed Hastings stepped down in the quarter
4. Ad-tier and paid sharing are ramping up well
5. Management outlined high expectations for the ads business

#1: Earnings results beat

The fourth quarter revenues came in at $7,852 million, up 10% (excluding the effects of FX). This was in-line with market consensus expectations of $7,856 million.

This was higher than Netflix’s guide of $7,776 million as a result of better net adds and tailwinds from FX.

Operating income came in at $550 million, implying 7% operating income margin. This was 44% higher than the market consensus of $383 million, as well as the company’s guidance of $330 million.

This beat in operating income was a result of the beat in revenue and a slower hiring in the quarter.

Lastly, the fourth quarter 2022 EPS came in at $0.12. This was lower than market consensus of $0.46 EPS and the company’s own guide of $0.36.

The main contributor to the miss in EPS was due to a non-cash unrealized FX loss on its Euro denominated debt, resulting in a $1.00 EPS headwind. Without this, the EPS for the fourth quarter would have come in at $1.12, beating the market consensus.

Lastly, FCF came in at $332 million for the fourth quarter of 2022, higher than the market consensus of negative $197 million.

Guidance beat on operating margins

While revenue guidance for the first quarter of 2023 is in-line with expectations, the 2023 margin guidance beat expectations.

For 1Q23, Netflix expects $8.172 billion in revenues, implying 8% growth on a constant currency basis. Furthermore, management expects revenue growth to accelerate over the course of the year.

Operating income guidance for 1Q23 came in at $1,625 million, somewhat in-line with consensus at $1,726 million.

The company noted it expects modestly positive net adds in 1Q23 with 2Q23 net adds exceeding 1Q23.

For the entire year of 2023, management expects that operating margins could come in between 18% and 20%. This is higher than the consensus at 18%.

Last but not least, management expects the company to generate $3 billion in free cash flows in 2023, beating market expectations.

I think what we are starting to see here is that Netflix has finally managed to stabilize the business, and we can expect re-acceleration from here.

#2: Subscriber metrics surpassed expectations

In the fourth quarter of 2022, Netflix grew paid subscribers by 7.7 million. This was well over the market expectation and company’s guidance of 4.5 million.

The strength in the subscriber metrics was across the board in all regions. In the United States and Canada region, paid subscribers were up 0.91 million, higher than the market expectations of 0.6 million new adds.

In the EMEA region, Netflix saw paid subscriber numbers increase by 3.2 million, surpassing the market expectation of 1.4 million increase in paid subscribers for the region.

In Latin America, Netflix added 1.76 million paid subscribers compared to market expectations of 0.7 million. Finally, for APAC, Netflix added 1.8 million paid subscribers compared to market expectations of 1.9 million.

The subscriber metrics trend is finally heading the right way after a tough start to 2022 and this is likely to be seen as an inflection point for Netflix as its business fundamentals stabilize and improve.

#3: The stepping down of Hastings as CEO

After more than two decades at the company, Reed Hastings announced that he has stepped down as CEO.

Netflix has operated under a co-CEO model, with Ted Sarandos being a co-CEO next to Reed Hastings. As a result of Hastings departure from his role as co-CEO, Greg Peters will now be co-CEO, alongside Ted Sarandos. Greg Peters was COO and now promoted to this co-CEO role.

Reed Hastings departure came as a surprise given his long tenure at the company, but he will continue to be executive chairman at Netflix. Furthermore, Hastings mentioned that the leadership transition has been planned for many years.

#4: Ad-tier and paid sharing ramping up

In the fourth quarter of 2022, while ad-tier drove new subs addition, it was a minority of the adds in the fourth quarter. Management also added that contribution in 2023 will continue to be minimal. That said, the take rate on the ad-tier has been solid, with little switching, while engagement is similar to that of the ad-free tiers. Lastly, the economics of the ad-tier are also better or in-line with management’s expectations.

For paid sharing, management expects to begin rolling this out more broadly in the later part of the first quarter of 2023. While this might drive churn, management expects this to be accretive to revenue quickly.

With its 30 million households in the US and Canada (“UCAN”) region, assuming 50% of these add a new account at $5 ARPU, this will drive mid-single digit percentage improvement in UCAN revenue growth in the long-term.

#5: Ads business to reach 10% of mix and surpass Hulu

In the quarter, management highlighted some of their own expectations for the ads business and what they see is the long-term potential for the business.

Firstly, management expects Netflix’s ads business to surpass Hulu’s, although it could take several years to achieve this. The fact that management has this conviction is encouraging to me as it speaks volumes about their own expectations of the ads business. Hulu currently has around $3 billion in ad revenue and $9 ARPU today, so this is likely the target to beat for Netflix over the next few years. Of course, I would expect this to be a multi-year journey and patience is needed for the results to be seen.

Secondly, management expects that the business will be able to reach at least 10% of the business mix in the long-term. I expect that it would take about five years to achieve this, baking in an expectation that the ads business makes up 10% of the total business by 2027.

The bottom line

Based on the recent fourth quarter 2022 results as well as the guidance and outlook for the first quarter 2023, I think that the worst is clearly over for Netflix. Subscriber trends are moving in the right direction after its weak subscriber trends earlier in 2022.

What lies ahead for Netflix? Execution in new growth areas will be key. Paid sharing and the ad tier plan will be the two growth areas for Netflix going forward, although both will take a few years to ramp and contribute meaningfully to the bottom line.

That said, I think that with the subscriber, revenue and profit trending in the right direction and management looking to target new growth areas, this leaves me positive on the stock in the long-term as Netflix seems to have found the bottom and has begun climbing from there.

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Disclosure: I/we have a beneficial long position in the shares of NFLX either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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