Still No End Game in Sight for Netflix

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Netflix stock - Still No End Game in Sight for Netflix

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Back in late 2015, Netflix (NASDAQ:NFLX) CEO Reed Hastings told owners of Netflix stock that the company would more or less break even in 2016, but added that it would generate “material profits thereafter.”

What that meant isn’t exactly clear. The company was already reporting operating profits at the time, and its net income, based on GAAP (generally accepted accounting principles) rules, was also positive. Hastings could have been referring to cash flow, which was in the red at the time. Cash flow is arguably the more meaningful indicator of success for Netflix stock, given the company’s unique business model.

But Netflix’s cash flow has not swung into positive territory, and its already-negative cash flow figures have worsened. And if Hastings was talking about actual net income, it’s a bit of a stretch to call the company’s net income “material” at this point, especially since it’s still technically bleeding cash.

Sooner or Later

Last quarter, NFLX turned nearly $4 billion worth of revenue into an operating profit of 89 cents per share, versus analysts’ consensus EPS estimate of 68 cents. Netflix’s top line, meanwhile, was roughly in-line with the consensus outlook. Its sales surged 34% year-over-year, and its net income soared 211%.

That’s the good news. The bad news is that the net amount of cash used in the company’s operations grew from $419.6 million in the third quarter of last year to $690.4 million last quarter. On a non-GAAP basis, Netflix’s negative free cash flow went from $464.9 million in the third quarter of 2017 to negative $859.1 million in Q3.

In the company’s defense, GAAP rules weren’t written with a company like Netflix in mind. Netflix’s business model involves securing the rights to content now and selling it to subscribers later. In the end, the company is looking to reap more subscriber revenue than what it must ultimately pay for the rights to television shows and movies. That approach is different from the business models of most companies.

On the other hand, to be considered truly viable, sooner or later all for-profit corporations have to generate positive net income and positive cash flow.

Netflix hasn’t done the latter yet, and given the trajectory of most of its financial results, it’s unclear if it will ever be able to do so.

The Fundamentals Are Troubling for Netflix Stock

Netflix’s fundamentals haven’t really changed since January. The company’s operational cash flow is dropping at a faster clip than its revenue is increasing. Moreover, its non-GAAP free cash flow — which is usually negative — is also deteriorating at a faster pace than its top line is growing.

Let that soak in for a minute. Netflix’s cash bleed is worsening at a rate faster than its sales are growing. That’s not a recipe for longevity.

But it’s not necessarily the end of the world for Netflix stock. We’ve seen plenty of other companies essentially mortgage their future to drive growth in the present. Amazon.com (NASDAQ:AMZN) comes to mind. Both Amazon and NFLX have been rewarding investments, even if their fundamentals have been less than sound.

Source: ThinkorSwim

Last quarter’s top line was only up 2.4% versus Q2, but both measures of negative free cash flow grew by double-digit percentage levels in just a mere three months. Something has got to give sooner or later, and one can ‘t help but wonder if tepid revenue growth is the new normal for the company now that competition from the likes of Walt Disney (NYSE:DIS) and even AT&T (NYSE:T) is on the verge of heating up.

The Bottom Line on Netflix Stock

This is not a clarion call to dump your Netflix stock. Hastings may well have a plan as to when the company will be able to stop spending so heavily on new content and simply coast as it collects monthly revenue from loyal NFLX subscribers.

If that plan exists, however, Reed Hastings may want to divulge at least some of the details of it sooner rather than later. The company’s net income and operating income are solid enough, but some investors were expecting the company to stop bleeding cash a while back. It’s not clear if the company will ever actually reach that point or how it will get there.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.


Article printed from InvestorPlace Media, https://investorplace.com/2018/11/still-no-end-game-in-sight-for-netflix/.

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