On October 18, Netflix (NASDAQ:NFLX) unveiled an impressive third-quarter performance, marked by substantial sales growth, a surge in global memberships, and a remarkable increase in free cash flow (FCF). With future plans to raise subscription prices, the prospect of further FCF growth has piqued the interest of value investors.
In Q3, Netflix reported sales that soared by 10.7% year-over-year, reaching $8.692 billion. Notably, this figure exceeded the Q2 revenue of $8.542 billion by 1.76%.
Furthermore, the streaming giant experienced a surge in global streaming memberships, with an addition of 8.76 million subscribers in Q3 over Q2. This represents a quarter-over-quarter growth rate of 3.7%, significantly surpassing the performance of the previous year, which saw a 10.8% increase in memberships.
The most remarkable news, however, was the surge in free cash flow (FCF), which leaped from $1.339 billion in Q2 to an impressive $1.888 billion in Q3. This staggering quarter-over-quarter growth rate of 41% hints at the company’s financial strength, although sustaining such a pace might prove challenging.
What’s more, this FCF represents a notably attractive FCF margin, standing at 22.1% of the Q3 revenue of $8.542 billion, offering insights into the potential for future FCF. With a Q4 revenue projection of $8.692 billion, applying a 22% FCF margin could result in FCF reaching $1.912 billion.
Analysts are optimistic, with forecasts indicating a revenue of $38.25 billion for the next year, reflecting a 13.7% increase from 2023 estimates of $33.63 billion. Applying the 22% FCF margin to this projected figure suggests that free cash flow could surge to $8.415 billion next year.
Additionally, the prospect of an FCF margin increase is bolstered by the minimal extra cost associated with the price hike planned for next year. This suggests that the company has substantial operating and FCF leverage, potentially leading to a forecasted 24% FCF margin, which, if realized, could result in FCF exceeding $9 billion.
For value investors, this compelling FCF outlook makes NFLX stock highly attractive. In the scenario where FCF reaches $9 billion next year, the market could bestow Netflix with a premium valuation. Using a 3% FCF yield, Netflix’s potential value could climb to as high as $305 billion, which is a significant leap from its current market capitalization of $178 billion.
Even with a more conservative estimate, employing a 5% FCF yield, NFLX stock remains undervalued. A forecast of $183 billion is derived by dividing $9.15 billion by 5.0%, marking a 2.8% increase over the current market value.
In essence, Netflix’s worth ranges between $183 billion and $305 billion. As FCF growth becomes more apparent next year, the stock is expected to experience upward momentum. The average price target is $243 billion, translating to a 36.5% increase over today’s valuation, bringing the stock price target to $550.90 (1.365 times the $403.59 price today).
Furthermore, an additional strategy for investors to consider is selling short out-of-the-money (OTM) puts to generate extra income, alongside owning NFLX shares. For example, for the November 10 expiration period, shorting the $380 strike price puts, positioned over 5.4% below today’s $403.59 price, could yield an immediate return of 1.36% over just 3 weeks.
In conclusion, the foreseeable increase in NFLX’s target price over the next year provides an opportunity for investors. One way to play this conservatively, while holding NFLX shares, is to sell short OTM puts, thereby generating supplementary income.
Featured Image: Unsplash
Author Faith Yakubu 
