Netflix: Still Overvalued After Q1 Earnings
Contributor since 2018 / 860 Followers
Summary:
- The net subscriber addition was weaker than the consensus expected.
- The 1Q23 free cash flow margin was better than the consensus expected due to the lower investment in content.
- Management’s 2Q23 guidance is not encouraging.
- NFLX’s relative valuation doesn’t look attractive.
- As a result of the reporting, I maintain my negative view on NFLX’s shares.
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Background
Netflix (NASDAQ:NFLX) reported neutral 1Q23 quarterly results. The negative effect of the weak net subscriber addition was offset by the positives from an increase in the free cash flow margin. As part of my last article, I noted the overvaluation of NFLX shares. Since my last article (it was published on January 20), Netflix’s stock price didn’t change significantly, while the S&P500 index was up 5% at the same time. It’s also worth noting that Netflix’s shares dropped to the level of $290 per share during the last quarter. However, the stock price returned to the January level at the end of the quarter. Nevertheless, the 1Q23 earnings report is far from encouraging and does not justify the high relative valuation of NFLX’s stock compared to other FAANGM and media companies. Let’s take a look at the company results to see why I keep my bearish view on the stock.
Revenue and subscribers
Quarterly revenue totaled $8.2 billion (+4% YoY, +4% QoQ), which was in line with the consensus expectations. Excluding the impact of the US dollar strengthening, revenue growth was 8% YoY. Recall that about 55% of NFLX’s revenue comes from regions outside the US and Canada. Net subscriber addition was worse than expected. While the consensus expected a net addition of 2.4 million, the actual addition was 1.7 million. In the 1Q22, there was a subscriber outflow of 0.2 million. Netflix’s total number of subscribers at the end of the quarter totaled 232.6 million.
Margin
Operating income was at $1.7 billion (-13% YoY, 21% margin), while consensus expectations were at $1.64 billion (20% margin). Free cash flow totaled $2.1 billion (26% margin), significantly better than the consensus expectation of $774 million. However, I note that the FCF result was better than expected, largely due to changes in working capital (lower content spending). EPS was at $2.88, 1% better than the consensus estimate.
Geographical breakdown
At regional breakdown, the largest subscriber addition was in the APAC region, where the company added 1.5 million subscribers during the quarter. Revenue in this region grew by 2% YoY to $934 million (+10% YoY excluding the F/X impact). Revenue in the U.S. and Canada region grew 8% YoY, with the 0.1 million subscribers addition. In the EMEA region, subscribers grew by 0.7 million and revenues were at $2.5 billion (-2% YoY, +6% excluding the F/X impact). In the LATAM region, the company added 0.5 million new subscribers and revenue was up 7% YoY to $1.07 billion (+15% in constant currencies).
Management guidance
Management guidance for 2Q23 assumes revenue of $8.2 billion, which implies a YoY growth of 3%. Excluding the F/X impact, growth is expected at the 6% rate. Operating profit is projected by management at $1.6 billion (operating margin of 19%, a year earlier, it was at 20%). Management attributes the possible margin decrease to the F/X impact. Also, the management confirmed the forecast of the operating margin for 2023 at 18-20% and raised the free cash flow forecast for the year to $3.5 billion ($3 billion was expected a quarter before). The increase in the FCF forecast was due to the halt in the growth of content investments. Management expects cash content spending to be at the level of $17 billion in the coming years. Also, management said it plans to ramp up share repurchases in the coming quarters.
Summary of reporting results
Positives:
(+) Investors were buoyed by strong cash flow. However, the FCF result was better than expected due to the changes in working capital (lower content creation spending).
(+) The FCF outlook for 2023 is also positive. The FCF forecast upgrade was due to the halt in the growth of content spending. Given the growth of competition, stopping the growth of content investment is not quite the right decision, in my opinion. Nevertheless, this step will improve the margin in the nearest future.
(+) The growth of buybacks. Management plans to ramp up the company share buyback rate in the coming quarters.
Negatives:
(-) New subscriber addition was weaker than the consensus expected. While the consensus forecast expected an inflow of 2.4 million subscribers, the actual inflow was only 1.7 million.
(-) Growth is not where it needs to be. Regionally, the largest subscriber addition was in the APAC region. The bad thing is that ARPU in this region is not impressive. It’s also bad that there are no significant subscriber additions in the US (only 0.1 million).
(-) The revenue forecast is not optimistic. Management’s 2Q23 forecast implies a YoY growth of only 3%. Excluding the F/X impact, growth is expected at 6%. The numbers are not very impressive.
Relative valuation
Netflix shares are trading at multiples that are higher than those of the two peer groups. Compared to the extended version of FAANGM, it is worth noting that Netflix has a forward EV/EBITDA of 21.2x, while the rest of the companies in this subgroup have the average multiple equals 15.4x. When compared with other media companies, the gap in valuation is even greater. Average forward EV/EBITDA for media companies is now 10.2x. At the same time, in terms of the ratio of the EV/EBITDA multiple to the sum of revenue growth and the FCF margin, Netflix also looks unreasonably expensive.
The situation is not new. It was similar before, when shares were more expensive than their peers for quite a long time. Then, Netflix stock’s fall was prompted by two consecutive bad quarterly reports (Q4 2021 and Q1 2022). Higher multiples relative to peers raise the risk of a significant fall in the event of poor quarterly results or other bad news in the future.
The final thoughts
I believe that NFLX’s current share price has already incorporated most of the positives associated with the rollout of the ad-supported plan and NFLX’s plan to solve account sharing problem. The positivity associated with the 1Q22 FCF results is excessive in my opinion, as it relates solely to the lack of growth in investment in new content, which could impact subscriber addition in the future, especially given the strong increase in competition. In addition, the content release schedule for the coming quarter does not inspire optimism. As a consequence, I maintain my negative view on NFLX’s shares and believe that a fair valuation level for the company stock is near $273 per share (DCF + multiple valuation).
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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