After a lackluster 2016, Netflix, Inc. (NASDAQ:NFLX) investors are enjoying a banner year in 2017, with NFLX stock making prodigious runs to all-time highs.
The ballyhoed FANG stock is currently basking in success after it crushed typical seasonality with impressive sub growth during the second quarter, and also managed to beat on the topline despite a slight miss on the bottomline.
NFLX stock now sits on an eye-popping 45% year-to-date return.
Netflix posted domestic net adds of 1.07 million vs. analysts’ consensus of 633,000 and another 4.14 million international subs vs. an expected 2.63 million. The company’s streaming membership now sits at an impressive 104 million, and boasts 75% of U.S. video streaming market share.
And, the company has now earned bragging rights as a truly global player: At 50.1% of customer base, international members have surpassed domestic customers.
NFLX Stock: Thin Profits and Massive Cash Burn
Netflix stock has been judged on subscriber growth for what seems like an eternity, with investors only paying fleeting attention to traditional metrics such as bottom line growth and free cash flow.
For the record, NFLX only sports thin profits (net income margin of 2.4%) and has never turned a full year of profits. The company has also posted negative free cash flow for three straight years. Add that to NFLX stock’s stretched valuation and you begin to understand why the stock is among the most volatile of the big cap growth stocks.
The bears are well aware of this, and are always waiting to pounce in a downmarket or whenever Netflix’s subscriber growth slows down. Netflix stock fared worse than other FANG stocks during the latest tech selloff.
The company reiterated that it expects to have a negative free cash flow of $2 billion in 2017, and is on the hook to pay a staggering $13 billion-plus in entertainment programming over the next three years.
Netflix is, of course, splurging on movies and TV series in a bid to offer something unique to its customers and build an even stronger competitive moat. Whereas this two-pronged strategy is likely to pay off in the long-term, it will continue being messy in the short-term. In fact, Netflix has said that it expects to have negative free cash flow ”for many years.’
No Fall Back Plan for Netflix Stock
The upshot of NFLX stock being judged almost exclusively on subscriber growth is that it’s likely to continue enjoying decent growth for long stretches. At 52 million international subscribers, Netflix has barely scratched the surface of the international video streaming market, one that is likely to hit a couple of hundreds of millions of subscribers in a few years.
The big downside is that NFLX investors essentially have nothing to fall back on whenever subscriber growth slows down for whatever reason. That’s a huge but real risk as the years 2014 and 2016 clearly showed us. NFLX stock invariably performs poorly whenever subscriber growth hits a speed bump. Studies have shown that the company’s domestic growth has kinda plateaued at 43% of U.S. homes with a streaming service, meaning growth here is likely to be limited going forward.
Netflix has little choice than to maintain leadership in international markets if it’s to create long growth runways. But this is not going to be a walk in the park. NFLX stock has had little to worry in the past from the likes of Amazon.com, Inc. (NASDAQ:AMZN) Prime Video and Hulu outside the U.S. But now it can expect to fight harder for subscribers since Amazon Prime Video expanded into more than 200 countries late last year.
Amazon is not anybody’s slouch, and plans to spend a staggering $5 billion on content in 2017 alone. Additionally, Hulu plans to soon start offering skinny bundles — that cable-killer service that has proven a hit with consumers.
Meanwhile, NFLX can also expect to increasingly battle it out with local content providers in the countries it serves.
Buy NFLX Only for the Long Haul
Investors tend to become very edgy whenever a company with high cash burn shows signs of slowing growth. The bears have never hesitated to short Netflix stock at any signs of trouble with customer growth, however small.
Any jitters in international growth could open huge downside risk for NFLX stock. Unfortunately subscriber growth is notoriously hard to model, and the company can just as easily miss on estimates as it can exceed them.
Buy Netflix stock only if you are willing to overlook the swings due to seasonality issues.
The good thing though is that NFLX appears to have a strong competitive moat thanks to its huge library of original content. It’s going to take several years at the very least before the likes of Amazon and Hulu can truly challenge Netflix.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
