Streaming giant Netflix Inc. (NFLX, Financial) reported earnings for the fourth quarter of 2018 after the market closed on Thursday. The company, which over the course of the last several weeks has rallied 51% off its December lows, was closely watched by analysts to see whether or not its red-hot growth story is running out of steam. Observers looking for a definitive answer to this question were left disappointed, as the report tells a complicated and somewhat contradictory story.
Financial talking points
Revenue came in at $4.19 billion, slightly missing consensus expectations of $4.21 billion. The stock traded down 4% from the open (although it has since regained some ground), reflecting investors' disappointment over the revenue miss.
There are reasons to be positive, however, as the number of new subscribers beat management’s own guidance - 8.8 million new subscriptions versus an expected 7.5 million. Earnings of 30 cents per share also beat expectations of 24 cents.
While the market reacted poorly to the revenue miss, bullish analysts interpreted the earnings release positively, with Goldman Sachs (GS, Financial), JPMorgan Chase (JPM, Financial), Bank of America Merrill Lynch (BAC, Financial), UBS (UBS, Financial) and Royal Bank of Canada (RY, Financial) all upgrading their price targets to between $420 a share and $480 a share.
Are the fundamentals sound?
Despite the increase in subscribers, the stock is radically overvalued. Over the course of the past month, Netflix has rallied more than any of its FAANG peers, putting it on pace to reach highs not seen since October, when uncertainty surrounding a potential economic slowdown began to set in.
Moreover, the company’s free cash flow burn continues to worry investors and analysts. In the fourth quarter, Netflix logged a deficit of $1.32 billion, for a total of $3 billion for the entirety of 2018. Management has indicated this problem will peak in 2019, but go down thereafter.
Another point that shouldn’t be overlooked is the company just initiated the biggest price hike in its history, increasing the popular $11 per month plan to $13. When asked about the increases on the earnings call, Chief Product Officer Greg Peters said management is confident the price hike will not have a chilling effect on new and existing subscribers:
“I think the model we’ve got is a fairly simplistic one, where we think our job is to effectively invest the money that our subscribers give us every month, so that we can give them incredible content in a better and better product experience," he said. "And if we do that well, we create more value for our subscribers and then occasionally, we’ll come to them and we’ll ask for a little bit more money, so that we can actually start that next cycle of investment”.
In other words, Netflix believes viewers will be happy to fork out a little extra cash every month in order to keep receiving the high-quality original content the company has become known for. Only time will tell whether this will prove true, but if the record numbers drawn by the recent "Bird Box"Ă‚ (80 million viewers) movie are anything to go by, then it would indeed seem there is demand for this blockbuster-quality content.Ă‚
Summary
Despite the revneue miss, sentiment around Netflix remains bullish. Ultimately, the market views Netflix as a growth company. As long as it can continue adding new subscribers, it will do well. Yes, the stock is extremely expensive and may scare off many value investors, but do not be surprised if Netflix extends its highly impressive rally in 2019.
Disclosure: The author owns no stocks mentioned.
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