Netflix earnings set to fall as cost increases outweigh revenue growth

Netflix is set to report a drop in first-quarter earnings when it reports on Monday 18 April, and market focus will be squarely on slowing US subscriber growth and the high cost of its global expansion and own programming.

Netflix
Source: Bloomberg

The TV and movie streaming company has just gone global, excluding China, and is increasingly commissioning and producing its own series. That’s driven up revenue, but it has also proved costly, and adjusted earnings per share are expected to fall to $0.084, from $0.151 in the previous quarter. Revenue is expected to increase 7.7% from the previous quarter to $1.964 billion.

Netflix’s stock price suffered a nasty fall after peaking at $129.29 in early December, as slowing US subscriber growth began to weigh on its lofty valuation. The company also announced a $2 increase to its monthly package last October that is set to come into force in May, which has heightened concerns that its new subscriber growth in the second quarter will be sharply impacted.

Netflix guidance for new subscribers in the first quarter is 1.75 million in the US, but this is expected to fall to between 500,000 and 700,000 in the second quarter with a number of analysts highlighting downside risks to even these low estimates.

The main concern is that Netflix has very high fixed future content obligations of more than $11 billion, which can only be met if average revenue per user (ARPU) and/or subscriber numbers continue to increase.

The bulls with high twelve-month price targets on the stock argue that slowing US subscriber growth can be made up through Netflix’s international expansion. Ex-US growth will be a key focus in the earnings release, but the concern is that the company runs into greater costs expanding into other markets and in some cases its subscription fees are comparatively high in other countries.

  P/E Ratio P/E 5-Year Average P/B Ratio P/B 5-Year Average
29/03/2013 273.7 141.8 13.1 7.9
28/06/2013 197.0 174.2 11.2 8.2
30/09/2013 211.6 210.1 15.2 10.1
31/12/2013 173.5 235.0 16.5 12.6
31/03/2014 132.3 197.6 14.3 14.1
30/06/2014 132.7 169.4 16.4 14.7
30/09/2014 120.0 154.0 15.8 15.6
31/12/2014 79.1 127.5 11.1 14.8
31/03/2015 108.5 114.5 13.2 14.2
30/06/2015 211.2 130.3 19.7 15.2
30/09/2015 273.8 158.5 20.4 16.0
31/12/2015 402.3 215.0 22.0 17.3
31/03/2016 359.6 167.2 19.7 17.0

 

The stock is still trading on 'lofty' earnings estimates. A price-to-earnings ratio of 359.6 means that it would take 359.6 years to earn back one’s initial investment in the stock. This is also a 192.4 premium to the 5-year average P/E ratio for the stock. Netflix is part of the FANGs (Facebook, Amazon, Netflix and Google) grouping of 'growth' stocks that have seen some of the sharpest share price falls so far in 2016.

Netflix stock hit an intraday low of $79.95 on 8 February, but has since recovered to above $100. However, much of the recovery in US markets since February has been driven by 'value' and 'quality' stocks — those that are cheap on valuation metrics and those that have solid balance sheets. 'Growth' stocks have comparatively under-performed and there is a growing fear that they have fallen out of favour as investors increasingly question their ability to realise the challenging future earnings that are priced into the stocks.

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The shares have been trading in a bullish channel since the stock bottomed on 8 February. It has basically retraced 50% of its decline from its early December peak. However, in recent trading the stock has clearly been running into a bit of resistance around the 50% Fibonacci retracement level.

The relative strength index also looks like it may be starting to roll over as well. The risk-reward for the stock certainly looks tilted to the downside given the stock’s high valuation, outsized negative reaction from recent earnings reports and the many issues that are starting to weigh on growth.

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