In the past couple of weeks, I’ve seen a lot of articles and some analyst commentary about which stocks could thrive during the coronavirus-related chaos. One name that keeps popping up as a coronavirus winner is Netflix (NASDAQ:NFLX) stock.
I hear what the Netflix bulls are saying. But I think a major part of their thesis is flawed in both the near term and the long term. Here’s a rundown of what the coronavirus outbreak means (and what it doesn’t) for NFLX stock.
The Coronavirus Bull Case
In a nutshell, the coronavirus bull case for Netflix is that people will hole up in their houses and watch Netflix rather than going out. In other words, people will essentially quasi-quarantine themselves until the worst of the outbreak has passed.
Bank of America analyst Nat Schindler says recent Netflix app download data seems to back up this thesis to a certain degree.
“Mobile app download data from Japan, Korea, and Italy all validate this thesis and show improving y/y growth and sequential trends from 2/21, the date where we saw the outbreak intensify in Korea and Italy,” Schindler says. “Potential strength in downloads relating to the ‘stay-at-home’ impetus during the COVID-19 outbreak may yield modest 1Q upside to Street numbers.”
Schindler says Netflix is among the least likely companies to have its first-quarter numbers negatively impacted by the coronavirus.
Bank of America has a “buy” rating and $426 price target for NFLX stock.
The Coronavirus Bear Case
I must admit when I read about the theory that people will watch more Netflix due to the coronavirus it made sense at first. But then I thought about it and asked myself so what? Netflix operates under a subscription model, which means it doesn’t matter if you watch one hour or 10,000 hours of content per month. Netflix is paid the same amount.
Schindler says international subscriber growth is likely up due to the outbreak, which is admittedly good news. But I have a hard time believing that many U.S. customers are subscribing to Netflix just because of the outbreak.
Needham analyst Laura Martin has a different take on Netflix’s international subscriber situation. International quarantines and travel restrictions have many workers around the world on leave due to the virus. Martin says Netflix will likely see a high churn rate in countries like France and Italy until users get some clarity on their financial future.
“Since NFLX is a luxury, we assume international churn will rise and offshore revenue growth will slow until COVID-19 retreats,” Martin says.
In addition, Martin says Netflix could be in big trouble if an economic downturn tightens credit markets in the near-term.
“NFLX has a junk bond credit rating and NFLX’s negative [free cash flow] profile demands access to capital,” she says.
Needham has an “underperform” rating for NFLX stock.
Longer-Term Outlook for NFLX Stock
I believe Martin hits the nail on the head when she talks about Netflix being a luxury. People subscribe to Netflix when they have disposable income. Times when people are fearful and uncertain about their jobs, their health and their financial situation are not times when they opt to spend more on entertainment.
I have long said Netflix’s biggest threat is the Disney+ service by Walt Disney (NYSE:DIS). But I believed that threat will not fully reveal itself until the next economic downturn. Unfortunately, we now seem to be on the doorstep of that downturn.
People may soon start looking at their budgets and identifying things to cut out. If they are carrying a cable TV subscription, an internet subscription, a Disney+ subscription and an Amazon Prime subscription, which of those services will be the first to go?
If you think Disney+, you may not have young children.
How to Play It
As Martin says, Netflix is a luxury. Luxury items don’t sell well during economic downturns. I’m sure plenty of Netflix subscribers will watch a ton of hours of content until the outbreak dies down. And some new subscribers may come aboard out of boredom. But I believe a surprising number of subscribers may actually cancel their subscriptions, especially if the market downturn carries over to a full-blown global recession.
Mix subscriber growth uncertainty with a bloated valuation, rising content costs, new competition and a business model heavily reliant on debt and you have a very risky cocktail in both the near-term and long-term. Netflix may end up weathering the coronavirus storm. But I believe risk is heavily skewed to the downside at the stock’s current valuation.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, he did not hold a position in any of the aforementioned securities.