Is Netflix Really Worth $500?

by Trefis Team
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Following a 68% rise since the March 16 lows of this year, at the current price of around $502 per share, we believe Netflix stock (NASDAQ: NFLX) is above its near-term potential. Netflix stock increased from $299 to $549 off its recent bottom, compared to the S&P which increased by around 45% from its recent lows. The stock has been able to outperform the broader market due to increased demand for streaming services during the ongoing pandemic. However, NFLX stock has dropped from $549 to $502 in a week, following lower than expected earnings in the recently announced Q2 2020 results. Despite dropping close to 9% in a week, the stock price is significantly above the levels seen during 2017-2019. We believe the company’s stock could decline by close to 5%, most likely to be led by a drop in its P/E multiple. Our dashboard What Factors Drove 162% Change In Netflix Stock Between 2017 And Now? has the underlying numbers.

Some of the stock price rise between 2017-2019 is justified by the 72% rise in Netflix revenues from $11.7 billion in 2017 to $20.2 billion in 2019, led by strong growth in the demand for streaming. This was further accentuated by net income margins almost doubling from 4.8% in 2017 to 9.3% in 2019. Netflix has been able to see such a remarkable rise in profitability as Netflix pays for its single largest expense – content – on a fixed cost basis, i.e. for every piece of content that Netflix either licenses or self-produces, it pays a fixed dollar amount regardless of how many people watch it or how many subscribers the company has. As a result, each additional subscriber comes with very little extra cost and is therefore profitable. On a per share basis, earnings registered a growth of 230% led by a sharp rise in revenue and margins while shares outstanding increased only marginally by 1.4%.

The rise in Netflix’s earnings was partially offset by a drop in the company’s P/E multiple until 2019. Netflix’s P/E multiple decreased from 149x in 2017 to 76x in 2019, which reflects a P/E decrease of close to 50% in 2 years. The drop in P/E multiple between 2017 and 2019 was mainly due to higher EPS, while the stock price did not register a corresponding growth as Netflix started losing subscribers in the US, driven by rising competition in the streaming space. However, the P/E multiple saw a marginal rise from 76x at the end of 2019 to 118x currently, mainly due to rising streaming demand on account of the coronavirus crisis.

What’s The Downside Trigger For NFLX Stock?

The global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. The shutdowns in major cities across the globe led to people sitting at home, which led to higher demand for streaming services and home entertainment options. This was reflected in the Q1 and Q2 numbers of Netflix. The streaming giant added 16 million subscribers in Q1 and another 10 million in Q2, taking the total addition to 26 million in the first six months of 2020. To put this into perspective, Netflix added 28 million subscribers in all of 2019. Q2 revenue touched $6.1 billion, a quarterly high for Netflix. Despite such an impressive subscriber and top line growth, Netflix stock dropped after the earnings announcement as Netflix reported earnings per share (EPS) of $1.59, about 12% lower than both management and analysts had anticipated. Lower earnings were due to Netflix reporting two non-cash charges that hit the bottom line – $119 million non-cash unrealized loss from (foreign currency) remeasurement on Euro-denominated debt and a $220 million non-cash valuation allowance for deferred tax assets.

Additionally, over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. compared to the rate seen in April-May to boost market expectations. Additionally, the gradual lifting of lockdowns is also giving investors confidence that developed markets have put the worst of the pandemic behind them. Following the Fed stimulus — which helped set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view, with investors now mainly focusing their attention on 2021 results.

As the lockdowns are lifted and people venture out for work and other reasons, streaming demand is likely to be lower than what was seen during the recent months of complete lockdown. Additionally, Netflix will have to compete with new entrants like Disney, AT&T and Comcast in the streaming war. The first six months of 2020 seems to be a one-time bonanza as the management has hinted at subdued growth over the next few quarters. Also, with investors’ focus shifting to 2021 numbers, Netflix is not expected to repeat its stellar performance of 2020 anytime soon, and surely not in 2021 as fresh competition will try to eat into its market share.

Subdued growth expectations and rising competition is expected to push Netflix’s P/E multiple close to 80x which gives us a fair price estimate of $476 for Netflix’s stock, thus reflecting a downside of about 5% from its current market price.

While Netflix’s stock is expected to see a downside from current levels, which S&P 500 component stocks have been consistent outperformers of the benchmark index? Our Consistent Outperformers: TDG, INTU, ROST, FISV, Have Beaten The S&P500 For 10 Years Running.

For further perspective of the streaming world, see how Disney compares with Netflix.

 

 

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