Netflix (NASDAQ:NFLX)
Following the release of its 4Q22 earnings report, Netflix’s (NASDAQ:NFLX) stock rose by about 7%. We remain pessimistic about the company despite a 40% beat in subscriber growth to 7.66M, compared to forecasts of 4.57M.
To put it mildly, 2018 was not Netflix’s best year. The streaming industry and the S&P 500 Index suffered from the stock’s near-51% decline in 2022. With the launch of its new ad tier in November and a change in management, we think that Netflix is now poised to reaccelerate revenue growth after a string of disappointing quarters. Yet, we think Netflix has a long way to go before recovering, so we don’t anticipate a stock price increase anytime soon. Our pessimistic outlook for Netflix in 1H23 stems from our expectation that the company’s robust subscriber growth won’t translate into substantial revenue growth in the near term due to the tougher spending environment. We think Netflix’s foray into the advertising-support service market is a strong long-term growth driver. Still, we don’t expect investors to see any tangible results soon. Due to the negative spending environment from 2022, businesses are slashing their advertising expenses. Until a more favorable entry moment in the stock market presents itself, we advise investors to remain on the sidelines.
The Incredible Rise in Subscriptions but Stagnating Income
We still think Netflix and its digital industry peers will struggle through the severe economic headwinds of 2022. Although Netflix’s 4Q22 earnings reports were well accepted by the market thanks to strong subscriber growth, we think the true success of Netflix in 1H23 can be seen in the company’s financials. It’s worth noting that Netflix has opted to discontinue offering subscriber guidance this quarter instead of concentrating on its other income sources, such as premium subscriptions, ad-supported tiers, and paid sharing options. Netflix’s 1.9% revenue increase was in line with projections but was the company’s slowest gain in revenue ever. Earnings per share were also down, as the business missed forecasts by about 77%. Due to economic challenges, we still await a quick recovery in Netflix’s revenue growth.
We think that Netflix’s tremendous subscriber growth this quarter proves that the firm can continue to drive memberships on the strength of audience devotion to certain high-hit content, with Wednesday being the latest example. With 1.196B hours of total watch time, the Adams Family spin-off quickly surpassed the original as Netflix’s second most popular original TV series. Although the firm didn’t provide exact statistics, the cheaper ad-supported plan also helped increase subscriptions. While Netflix’s operating income increased by 7% in 2022, above forecasts, the company’s operating margin declined to 17.9% from 20.7% in 2021, leading us to conclude that the streaming service is still having financial difficulties. There is still a long way to go before we see sales growth at this firm again. During several previous quarters, Netflix’s revenue growth has slowed.
We maintain our belief that Netflix is hindered by the poor expenditure environment and will begin rebounding in 2022. More specifically, we divide our bear thesis into two parts:
- The decline in ad-tier gains is slowed by the weakening current economy
In response to user complaints over a planned price increase for new subscribers in early 2022, Netflix introduced its “Basic with Ads” plan in November. Subscribing to the ad-supported tier costs $6.99 per month, a savings of $55. The digital advertising industry is expected to expand at a compound annual growth rate of 13.1% from 2023 to 2028. Therefore we are optimistic about the long-term effects of Netflix’s ad-tier plans. However, the slowdown in ad expenditure amid economic headwinds means that Netflix will likely see returns from the ad-tier strategy sometime soon. Since Paramount missed revenue projections in 3Q22, apparently owing to reduced ad income, we think this is a solid indicator of the overall strength of the advertising industry. We predict that the sluggish spending environment has had a detrimental influence on advertising expenditures, which will prevent Netflix’s ad-tier subscribers from significantly increasing profitability via ad revenues. According to Insider Intelligence, there will be a continuation of the dismal ad spending of 2022 into 2023, with 30% of large advertisers reporting ad budget cutbacks and another 74% claiming that the economic slowdown would impact their budget selections. To bridge the gap between the Basic with Ads and regular subscription tiers, we expect Netflix to substantially leverage its ad-tier base via the ad spending market, which we expect to be around for a while.
Netflix has a lot of ground to make up in the ad market before it can compete on a significant level with established players, and that’s before we even consider that ad spending is down overall. In response to this question on the earnings call, Netflix COO and CPO Greg Peters said that the company needs “some time” before it can compete with Alphabet or Meta Platforms in the advertising arena. We believe that Netflix is positioned to increase its ad income, but we do not anticipate this to happen materially in 1H23.
- Making up for the year 2022
Netflix is a household brand and the leader in the streaming business, but the firm took a blow in 2022, and we feel that a large part of what Netflix is facing now is a rebound from the lows of last year, both in terms of increasing its member base and restoring revenue growth. Most of Netflix’s income comes from markets outside the United States. Thus we think the strong USD was a significant headwind for the firm in the previous year. We attribute a large portion of Netflix’s 6% Y/Y revenue growth in FY2022 to foreign exchange (FX) headwinds. Since the US dollar index, which measures the dollar’s strength or weakness against a basket of other currencies, has fallen from its 52-week high in September, our worries about FX headwinds eating away at revenue in 1H23 have subsided. We anticipate the company’s challenges will ease somewhat as the strong USD has deflated. However, if the stronger USD returns in 2023 are due to market uncertainty, we anticipate that the company’s diversified geographic revenue sources may expose it to significant FX headwinds.
Valuation
Trading at 25.1x C2024 EPS $14.48 on a P/E metric is pricey compared to the peer group average of 20.2x. Netflix stock sells at 4.4x C2024 EV/Sales, higher than the industry average of 2.8x. We think the stock is overpriced and suggest that investors hold off on buying until the price drops.
Financial Market Report
Despite some bearishness and bullishness, Wall Street is generally more optimistic about Netflix. The stock has a 21 buy rating, 19 hold rating, and 12 sell rating from the 43 analysts following the stock. Netflix stock is currently worth $363 per share. The average rating from the selling side is $354, with a median of $352.
Stock Investment: What to Do with It
We maintain our sell rating on Netflix since we do not anticipate a stock price recovery in 1H23. We anticipate that the growth of Netflix’s subscriber base will have a small but positive effect on the company’s bottom line shortly. We anticipate that Netflix is still under pressure from economic factors, particularly the weakening ad spending that may impede its ad-tier aspirations. Our long-term outlook for Netflix stock is optimistic because we think the company is now moving correctly to ignite sales growth, but we do not see this occurring anytime soon. Although we will continue to follow Netflix’s progress, we now advise investors to sell their shares and return to them once they have considered the stock’s potential losses.
Featured Image: Freepik @ Grinvalds
