Netflix Stock (NASDAQ:NFLX)
Netflix (NASDAQ:NFLX) is on the right track once more. The company added 7.66 million members in 4Q2022, indicating that the subscriber drop in 1H2022 is now over. Despite increased competition in the streaming industry, Netflix remains the obvious leader. The company continues to demonstrate its ability to extend its content portfolio with appealing products, which should help it maintain its value proposition. Furthermore, the recent initiatives taken by management (the introduction of an ad-based tier and the implementation of a program to combat password sharing) should be revenue accretive in the coming years. However, the share price has risen dramatically, gaining by 22.3% year to date.
The company now trades at a 2-year projected P/E of 23x, indicating that the value mostly reflects low-teen sales growth and a 300 basis point increase in net profit margin. Unless and until I see more reasons for revenue growth in the high teens (or more), my current rating for Netflix stock is a Hold.
A Return to Subscriber Growth
Netflix has effectively returned to positive subscriber growth in the second half of 2022. The company saw a significant rise in subscribers during the early stages of the pandemic but was unable to capitalize on that momentum. The subscriber base declined in the first half of 2022, causing investors to fear that the company’s boom days are over owing to the increased competition in the streaming market.
What I admire about Netflix’s 4Q2022 figures is that subscription growth has returned in all markets. The company’s most mature market, the United States and Canada (UCAN) had been struggling to grow subscribers. UCAN has struggled to show noteworthy growth over the last two years, with 5 quarters of growth is either zero or negative. This is why I am overjoyed to see UCAN report a 1.1% increase in subscriptions in 4Q2022. Europe, the Middle East, and Africa (EMEA) also experienced a robust recovery in the quarter, with subs increasing by 4.3%.
A Stronger USD Causes ARM to Fall
In 4Q2022, Netflix reported a 2% decrease in Average Revenue per Membership (ARM). However, when adjusted for F/X movements, the F/X neutral ARM increases by 5% year on year in 4Q2022. The stronger USD will be a huge obstacle for Netflix in 2022, as international markets now account for 55% of its streaming revenue. I feel it is critical to consider the F/X neutral ARM when assessing pricing power, and I see no cause to be concerned.
The factors that contributed to the revenue decline are easing. Netflix’s revenue climbed by only 6% in the fiscal year 2022 to $31.6 billion. This 6% gain in the top line, deemed modest for the stock, was attributable to F/X pressure and a slowdown in subscriber growth. I believe that the initiatives taken by management (the introduction of an ad-supported tier and the deployment of a program to combat password sharing) will be major growth drivers (along with the ever-improving content slate). This is why I believe the stock can easily meet management’s revenue growth forecasts in the low teens.
Because of operational leverage, the operating profit margin has the potential to grow.
In the fiscal year 2022, Netflix’s operating profit margin was 17.8%. Due to the inherent operating leverage in the business, management anticipates a 100-200 basis point increase in the operating profit margin for FY 2023. This is an important area for the organization to examine because it is what leads to an increase in FCF generation.
Because of the complexity of management’s operations, short-term risks remain significant.
I believe the major concerns for the company are rising investor expectations, particularly those focused on subscriber growth. The crackdown on password sharing is highly likely to have some early negative consequences, as management referred to in its Q4 2022 earnings presentation. This could result in some turnover for the next quarter or two. Furthermore, the ad-based tier is likely to result in subscribers downgrading to the lower plans, and we do not yet know if the revenue earned by ads will be enough to fully balance the lost revenue. Overall, I feel that these risks are of short duration and should not have an impact on the medium-term outlook for the stock.
3-Year Forecast and Valuation
I created three scenarios for Netflix, the first of which largely mirrors management instructions. For the base scenario, I assumed a 13% compound annual growth rate (CAGR) for the next three years, with a 150 basis point increase in net income margin (I am assuming that the expansion in the operating profit margin will flow to the bottom line). In addition, I created two more scenarios: a bull case and a bear case.
I calculated the implied P/E ratio for each scenario, and I feel the stock price has already risen to reflect the worst-case scenario outlook. I believe the market now expects Netflix to return to high-teens top-line growth. This is not impossible, but it takes near-perfect execution on Netflix’s part in terms of the additional activities that management is taking. I would not bet against this company, but I would need to see more proof of continuous growth before I would subscribe (pun intended) to the bull-case scenario.
Netflix managed to record great results in 4Q2022, putting a stop to the downturn it experienced in H1 2022. Furthermore, there are ample reasons to believe that this recovery will have legs, leading to revenue growth and margin expansion. There is some concern about churn in the short term as the corporation takes steps to eliminate password sharing; however, this should only be a temporary concern. I believe that the share price’s YTD rise has been justified, and Netflix stock appears to be properly valued. I advocate holding the company since there is potential for growth surprises in the coming quarters.
Featured Image: Pexels @ cottonbro studio