Netflix: Q2 Offers Cause For Optimism But Best To Stay On The Sidelines For Now
Contributor since 2021 / 294 Followers
Summary:
- Netflix’s Q2 earnings report showed revenues of $8.19 billion, slightly below estimates, but EPS of $3.29 beat expectations. The company added 5.9 million subscribers during the quarter.
- The company is focusing on sports documentaries rather than live sports broadcasting, with recent releases proving popular. Strikes in Hollywood are not expected to significantly impact the company due to its international content.
- Netflix plans to accelerate buybacks in the second half of 2023, with $3.45 billion left for this purpose. The company’s valuation remains unchanged, suggesting it is fairly valued with barely any upside.
JC Olivera/Getty Images Entertainment
Introduction
The last time I wrote about Netflix, I highlighted the company’s need to prioritize sports broadcasting in order to unlock its next leg of growth. In this article, I talk about the company’s second-quarter earnings report and what the management plans to do with respect to sports streaming. I also argue why the ongoing strikes are not going to have as much of an adverse impact on the company compared to its peers.
A Snapshot of Q2 Earnings
The company, in my opinion, had a decent quarter. There was nothing spectacular about the results, which probably explains the dramatic pullback that was seen in the stock post the report. While second-quarter revenues of $8.19 billion came in below estimates by $103.2 million, EPS of $3.29 comfortably beat estimates, coming in $0.43 above expectations.
The company’s password-sharing crackdown resulted in strong subscriber growth, as NFLX added 5.9 million subscribers during the current quarter, compared to a loss of nearly 1 million during the same period last year. Moreover, the initial trend that the company is seeing with the new subscribers is that they are displaying characteristics similar to those of the company’s existing long-term subscribers, that is, they appear to be more engaging, which implies that there is a higher probability that they can be retained.
NFLX’s advertising strategy also remains on track, with the company seeing memberships for its ad plan nearly doubling on a sequential basis, although it is not a significant needle mover, yet, for the company.
Finally, the ongoing strikes, which have now become a two-headed monster now that the actors have also joined the writers in the picket line, have forced the company to cut on content spending. This allowed the company to raise its free cash flow forecast for FY23 to $5 billion, which represents a significant jump from the initial forecast of $3.5 billion.
Netflix is Interested in Sports, Just Not Live Sports
One of the highlights from the company’s Q2 earnings call was its plans related to sports broadcasting. While management did reiterate that it was interested in sports streaming, the company was more geared towards “sports adjacent programming,” in the form of sports documentaries, rather than live sports broadcasting, as evidenced by its latest releases Quarterback, created in partnership with the NFL, and Tour de France: Unchained.
Sports documentaries are an area that NFLX is familiar with, given its success with Drive to Survive, Break Point, and Full Swing. The question though, is to what degree can these be sustainable and engaging compared to live sports broadcasting? Early signs indicate that the latest launches have been a hit with critics and viewers alike, with Quarterback receiving an 83% rating on Rotten Tomatoes. If these shows become as successful as Drive to Survive, then the company will have yet another differentiating factor compared to its peers. It would also allow various sports organizations to partner with NFLX in the hopes of luring the company’s massive subscriber base to live games. Therefore, if this is indeed the strategy that the company has decided to pursue in the sports category, then it’s vital that it pours significant resources into it, given the overall diversification potential of this category for the company.
Moreover, it is not only the content but also the timing that matters when it comes to sports documentaries. In my opinion, NFLX missed a tremendous opportunity, in the build-up to the Women’s Football World Cup, to release a documentary on women’s football, especially since the U.S. Women’s National team is the defending champion and this year’s tournament will be the last for legendary U.S. forward Megan Rapinoe. A documentary on her life post event could definitely make up for this lost opportunity, assuming that the company has plans for one. Furthermore, with the upcoming Cricket World Cup set to be played in October, it would also be great if they release a related documentary closer to the time, especially since it would give the company a huge boost in one of its underpenetrated markets, India, who is hosting the current iteration of the tournament.
All things considered, the sports documentary option is a viable alternative to live sports and initial signs show that it has the makings of a successful strategy for NFLX. Going forward, however, how it builds on the initial success of this strategy will be crucial for its growth prospects.
Netflix’s Current Content Should Act as a Shield Against Ongoing Strikes
The ongoing writers’ and actors’ strikes may have brought Hollywood to a complete standstill for the foreseeable future, but as far as NFLX is concerned, they are unlikely to have as much of an adverse impact on the company in my opinion, compared to traditional Hollywood studios, at least in the near term. This is despite the writers making streaming companies such as NFLX their main target.
NFLX will be able to protect itself from the ongoing strikes due to its existing content library, especially its international shows and movies. For instance, the company’s upcoming content includes the second volume of the third season of The Witcher, the fourth season of The Upshaws, the action thriller Heart of Stone, starring Gal Gadot and Alia Bhatt, and the second season of the Japanese anime Baki Hanma. NFLX’s international shows and movies have been a game changer for the company given their success with subscribers all over the world. To offer some context, shows such as Physical 100 (Korea), Alice in Borderland (Japan), The Snow Girl (Spain), and Que Viva Mexico along with movies such as Hunger (Thailand) and AKA (France) have all been major success stories in the U.S. Given that the strikes are occurring in Hollywood, Netflix’s international production should remain largely shielded, allowing it to continue to release more international content in the coming weeks and months.
As a result, while NFLX, like its peers, will want the situation resolved as soon as possible from a long-term perspective, the company is unlikely to be as badly affected as others.
Buybacks are Set to Accelerate in the Second Half of 2023
Finally, investors in NFLX could also be in for some windfall in the form of buybacks for the second half of this year. The company still has $3.45 billion left in its war chest for buybacks and given that its existing cash levels of $8.6 billion currently remain above its target levels, management does have plans to increase the buyback activity in the second half, which should be a near-term catalyst for the stock, albeit not a significant one in my opinion.
Valuation
|
Forward P/E Multiple Approach |
|
|
Price Target |
$428.00 |
|
Projected Forward P/E Multiple |
35x |
|
PEG Ratio (NTM) |
1.65 |
|
Projected Earnings Growth |
21.2% |
|
Projected FY24 EPS |
$12.24 |
My valuation for the company remains unchanged from last time since the changes to my assumptions are minimal, if any. For instance, the company’s Q2 revenues of $8.2 billion, which represent a YoY growth of 3%, came in line with the company’s expectations, and slightly below my estimate of $8.4 billion. The company now expects Q3 revenues of $8.5 billion, which would represent a sequential growth of 3.7%. If the company maintains the same sequential growth for Q4, then total FY23 revenues would now be $33.7 billion, a marginal decline from my previous estimate of $34.1 billion.
I have assumed operating margins of 18%, which translates to an operating income of $6.07 billion. I have maintained the non-operating expenses for the company at $380 million and the tax rate at 22%. This results in an updated net income of $4.44 billion, a slight decline from my previous estimate of $4.5 billion. According to Refinitiv, the number of shares outstanding now stands at 443.15 million, which results in an FY23 EPS of $10.10.
I have assumed a forward P/E of 35x and a forward PEG ratio of 1.65x, the same as last time, which suggests an EPS growth of 21.2%. This results in an FY24 EPS of $12.24. At a forward P/E of 35x and an FY24 EPS of $12.24, we get a price target of about $428, unchanged from last time, which is around the level where the company is currently trading.
Risk Factors
While NFLX might be somewhat shielded from the ongoing strikes, it’s not fully immune to them. From a long-term perspective, it is vital that the company continues to offer fresh domestic content, especially future seasons of its hit U.S. shows. Therefore, a swift resolution to these strikes is crucial for NFLX to maintain its long-term growth.
Furthermore, the impact of the password crackdown cannot be fully ascertained yet, especially in key markets such as India, where there are plenty of local competitors that offer a lot more local content, thereby making them a significant threat.
Concluding Thoughts
The second quarter did offer a lot of positive takeaways for NFLX and also offered a lot more clarity with regard to the company’s plans related to live sports. Opting for sports documentaries over live sports is an astute move in my opinion, especially since this is an area that the company is already familiar with.
The password crackdown and its advertising strategy are both progressing positively with the company not having to face the kind of backlash that would have worried investors. Finally, with a significant increase in buybacks on the horizon, the stock, in the near term, could also appeal to income-loving investors.
However, from a valuation perspective, nothing has changed since the last time I talked about the company. It continues to remain fairly valued with barely any upside. If the current pullback in the stock on the back of its earnings report gathers steam, then it could offer a potential buying opportunity down the line. For now, it’s best to stay on the sidelines with a bucket of popcorn and enjoy the company’s exciting content.
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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