Netflix Q1 Earnings: Lost Squid Game, Further Drop Expected

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Investment thesis

As of April 20, 2022, Netflix, Inc (NASDAQ: NFLX) has lost 62% of its value since the start of 2022. In its previous FQ4’21 earnings call, NFLX lost 21% of its value, falling from $508.25 on January 20 to $397.50 on January 21 January, when it reported weaker than expected subscriber growth with an even weaker forecast for FQ1’22. Three months later, it’s deja vu time, when the stock has bled another 35%, from $348.61 on April 19 to $226.19 on April 20, 2022. With trading volume more than 26 times the usual on April 20, it is evident that many institutional and retail investors lost faith and fled with their remaining capital.

We will discuss what the future holds for NFLX now.

What happened to Netflix subscriptions?

NFLX Subscriptions

Netflix subscription trend

S&P Capital IQ

The only reason NFLX has fallen so hard and fast is that the company again missed its own forecast for subscription growth in the first quarter of 2022. The company previously guided a 2.5 million subscriber increase for the quarter, as reality hits hard with a drop of 200,000 instead. Demand for the streaming service fell the most in the UCAN region at -640K, with LATAM and EMEA reporting declines of -350K and -310K, respectively. Despite a remarkable growth of 1.09 million subscribers in the APAC region, this was obviously not enough to cover the shortfall in other regions. Although the suspension of its service in Russia represents a drop of -700,000 subscribers, a net increase of 500,000 is still well below its forecast.

Intense competition for the streaming service

Intense competition for the streaming service

Neftlix press release

NFLX had attributed the slowing growth to multiple factors, including intense competition from other streaming services, macro factors such as inflation and rising interest rates, profiteering of more than 100 million households, representing almost half of its existing subscriptions of 221.64 million on FQ1’22. In the UCAN region alone, the company reported more than 30 million unmonetized users, representing 40% of its current subscriptions. Based on an average revenue of $11.83 per membership, NFLX had lost at least $3.54 billion in revenue in the first quarter of 2022, which is more than $14 billion in annual revenue. It’s no wonder that the company has decided to double the monetization of profiteers in the future.

As a result, it would make sense for NFLX to adopt an ad-supported plan, which would help attract churn again, partly attributed to its price increases. The new plan would help reduce friction for those concerned about inflation and rising interest rates. Additionally, an ad-supported plan would help boost its penetration in low-income countries with low purchasing power, such as its current trial in Chile, Costa Rica, and Peru. NFLX competitors, such as Disney (DIS) and HBO Max (WBD), had previously reiterated their goal of releasing ad-supported levels. However, since the plan would only be fully rolled out in the next few years, its incremental contribution to revenue and subscription growth would be slow.

Although NFLX has also entered the gaming market, its contribution would still be minimal, given that most of its subscribers are here for the streaming service. As a result, recovering its stock would take some time, though we can expect a slight increase in its loaded content roster in H2’22.

Netflix is ​​still somewhat profitable, for now

NFLX Revenue and Net Profit

Netflix Revenue and Net Income

S&P Capital IQ

Over the past five years, NFLX has grown its revenue at a CAGR of 28.05%. In the last twelve months (LTM), the company recorded revenue of $30.4 billion and net revenue of $5 billion, representing excellent year-over-year increases of 21.6% and 81 .2%, respectively. For FQ1’22, NFLX recorded revenue of $7.87 billion, representing an increase of 2% QoQ and 9.9% YoY. The growth is mainly due to recent rate increases. Nevertheless, its net profit is comparatively lower at $1.6 billion in FQ1’22 than at $1.71 billion in FQ1’21, taking into account the increase in its operating and R&D expenses for the trimester.

NFLX FCF, operating expenses, cash and equivalents and FCF margins

Netflix FCF, operating expenses, cash and equivalents and FCF margins

S&P Capital IQ

However, if we were to investigate further, we would realize that NFLX’s finances are not quite sound yet. Over the past five years, the company has yet to report sustained positive free cash flow (FCF) and margins. NFLX reported FCF of -0.03 billion and FCF margins of -0.1% in LTM, while spending over $6.45 billion in operating expenses. It included $2.4 billion in R&D, $2.58 billion in sales and marketing expenses, and $1.45 billion in general and administrative expenses. The company has also increased its operating expenses over the years, at a CAGR of 24.11% since fiscal 2016. Additionally, NFLX does not appear to be slowing down its operating expenses, given that it constantly has to produce new content to attract new subscribers. Nonetheless, the company still has substantial cash and cash equivalents of $6.01 billion at FQ1’22. NFLX Co-CEO and Head of Content, Ted Sarandos, says:

While we weren’t happy with the growth in subscribers, we certainly found that the new season of Ozark, Inventing Anna, the Adam project and certainly, most important of all, the new season of Bridgerton, delivered exactly as expected – actually a little bigger than expected with fans. Now, of course, we think we have to, and we have to have a Project Adam and one Bridgerton each month and to ensure that it is the expectation of service at all times. (Looking for Alpha)

Projected Revenues and Net Income from NFLX

Netflix Projected Revenue and Net Income

S&P Capital IQ

Over the next five years, NFLX is expected to experience revenue growth at a CAGR of 9.86%. While this represents a clear deceleration in revenue growth, the company is expected to double its net profit profitability over the next five years, from $5.11 billion in fiscal 2021 to $10.17 billion. for fiscal year 2026. For fiscal year 2022, consensus estimates that NFLX will record revenue of $32.55 billion and net income of $4.98 billion, representing annual growth of 9.6% and a decrease of -2.5%, respectively. Nonetheless, the company achieved revenue of $8.05 billion and net revenue of $1.35 billion for FQ2’22, representing a year-over-year increase of 9.6% and in line with revenue nets of FQ2’21, respectively.

So is NFLX Stock a buySell ​​or Keep?

NFLX is currently trading at an EV/NTM turnover of 3.38x, below its 3-year average of 7.5x. It is evident that the stock was previously overvalued as a high growth stock during the pandemic, due to its massive growth in subscriptions and revenue at the time. Despite its relative undervaluation, consensus estimates downgraded the stock to a hold, due to the apparent decline in its subscription growth.

From our perspective, NFLX has finally come down to earth, after skyrocketing valuations over the past three years. As it stands, the stock is finally in line with its peers, such as Disney (DIS) with EV/NTM revenue of 3.18x, although still relatively high compared to Warner Bros. . Discovery (WBD) with 1.42x. Given its lack of economic and IP moat compared to Disney theme parks, Marvel Studios franchises, Pixar and Lucas Film, we expect NFLX’s valuation to potentially halve.

Since it will take some time for NFLX to win back profiteers and the ad market, we also expect the stock to continue to retrace over the next few quarters. As a result, tech investors looking for price floors may have to wait longer. In contrast, we advise existing NFLX investors to cut losses and run first, before potentially adding once the stock bottoms out.

Therefore, we rate NFLX stock as a sell for now.