One of the most interesting stock stories in the market this year has been Netflix (NFLX, Financial). Shares in the company consistently defied expectations over the past 10 years. In the last five years, the company's growth has accelerated rapidly, catapulting the business into the leagues of the biggest companies in the U.S.
Growth potential
According to Wall Street analysts, the company's revenues could hit $38 billion by 2023, an increase of nearly 400% from 2016.
The Coronavirus pandemic provided a real boost for the business. Stuck-at-home consumers had nothing else to do but watch television, and with one of the largest content catalogues available, many of these consumers turned to Netflix.
However, the pandemic didn't necessarily create new demand. Rather, it accelerated trends that were already in progress in the global streaming market. This doesn't just apply to subscriber growth. Companies like Disney (DIS, Financial) accelerated their streaming rollout plans as well, making more content available for subscribers. Money is also flooding into production. It seems as if every single content producer now has a unique offering that consumers need to pay a monthly subscription for.
In other words, the market is becoming crowded, and Netflix is no longer the only game in town. Consumers increasingly have to make a choice between streaming services.
Against this backdrop, it is unsurprising the company's growth is slowing. In the first quarter of last year, Netflix picked up 3.98 million new subscribers. The company now forecasts subscriber growth of 2.5 million for the first quarter of this year. That’s a big drop in growth.
This cautious outlook has sent the stock plunging. From a high of around $700 in November of last year, the stock is now changing hands at about $370.
What is noticeable is the fact that this sell-off is pretty widespread across the streaming sector, suggesting investors believe the slowdown will spread to other companies.
Interestingly, shares in Netflix have been under pressure even though the company is in a much stronger position today than it has ever been before. The company generated positive cash flow in 2021 and expects to remain cash generative for the foreseeable future. As such, for the first time in its history, it is no longer reliant on investor financing to keep the lights on and fund content development and licensing spending.
This is a huge step forward for the business. I have always avoided the stock because of its extensive liabilities and reliance on the kindness of strangers. Now it looks as if the company can stand on its own two feet. Now the company has reached this landmark, one of the significant risks hanging over the stock has been removed.
Sticky customers
Netflix's business model has always interested me. Its subscription service has become a non-negotiable spend for some consumers, which gives the enterprise an air of defensiveness. Its cash flows are relatively stable and predictable, and it can increase its subscription prices. Consumers are unlikely to notice a 5% per annum increase in prices. Even if they do, it's such a small expense that they are unlikely to cancel the subscription, especially when one considers the amount of entertainment value a Netflix account provides.
The sticky nature of the client base is the primary reason why I think the stock now offers an interesting opportunity. Based on Wall Street growth projections for 2023, the stock is trading at a forward price-earnings ratio of just 25. This seems incredibly cheap for a business with a sticky customer base and the potential for substantial revenue and profit growth in the years ahead.
Indeed, even if the company's subscriber growth falls to zero, it still has the potential to grow earnings through price increases. In some respects, this gives the business similar qualities to a utility provider. Though, if growth falls off too much, investors may not be willing to give the stock decent valuation multiples.
All in all, I would not say I'm a buyer of the stock at current levels, but it is certainly starting to look interesting.
