Netflix (NASDAQ:NFLX) has been surging since the outbreak of the Covid-19 pandemic. NFLX stock is up nearly 50% since the market sell-off in mid-March.
The company’s streaming service is getting a (hopefully) once-in-a-lifetime opportunity. It seems that even consumers who held out from the streaming service are giving Netflix a try, and for obvious reasons.
Many Americans are unemployed. And even those that are working from home have more than enough time on their hands when they’re not working. Live sports are not available. Consumers can’t go to restaurants or movie theaters. It’s been the perfect storm for binge-watchers.
But investing in Netflix is not without risk. And that was a sentiment confirmed by none other than Netflix CEO, Reed Hastings who confirmed that it may be difficult for the company to replicate its recent growth.
Sobering Earnings and NFLX Stock
In April, Netflix delivered a split earnings report. The company delivered slightly higher-than-expected revenue of $5.77 billion.
However, the company reported earnings per share (EPS) of $1.57, which was lower than analyst expectations for $1.64 EPS. That bad news was actually really good news as the EPS was more than double over the same period the year before.
But Netflix’s CEO issued this statement in the letter to shareholders that accompanied the earnings report:
At Netflix, we’re acutely aware that we are fortunate to have a service that is even more meaningful to people confined at home, and which we can operate remotely with minimal disruption in the short to medium term. Like other home entertainment services, we’re seeing temporarily higher viewing and international revenue, resulting in revenue-as-forecast. We expect viewing to decline and membership growth to decelerate as home confinement ends, which we hope is soon.
I applaud Hastings for his candor. But it is clearly an indication that Netflix is expecting a slower rate of growth in the second half of 2020.
Netflix Faces Multiple Threats
Los Angeles County just announced that it will likely continue the stay-at-home order through August. Other states are clearly going to be slower to open than others. On the surface, this would appear to be good news for Netflix and its streaming service.
However, Netflix may not benefit from a prolonged lockdown for two reasons. First, as expansive as the company’s library is, it is finite. And while Netflix does have some syndicated content, it relies on its original content to separate itself from the competition.
And that’s the first problem. Netflix has just started to create new content. So if you’ve watched all three seasons of Ozark, you’ll have to wait quite a while for Season 4 to drop. Connoisseurs of The Office only have the cult comedy available on Netflix through the end of the year.
This isn’t a condemnation of Netflix. It’s just that there will come a point when consumers will have viewed all the content they want or have the ability to view.
But that also exposes a second concern for NFLX stock. People are starved to do something, anything. And as the weather warms up, consumers will be spending less time indoors. They may have limited places to go, but it’s likely they will be looking to spend time outside.
Producing Content Is Expensive
There’s one more thing to be concerned about. Producing content is expensive. And prior to the Covid-19 pandemic, Netflix was burning through cash.
In that regard, the company was in a win-win situation at the outset of the pandemic. Netflix was adding revenue while their expenses were curtailed while production was shut down.
At the end of last year, Netflix said its cash burn would peak in 2019 and then start going down. However, that may not be the case in a post-virus world. Producing more content may get more expensive as additional safety protocols are put in place.
What to Expect From NFLX Stock
A slower rate of growth does not mean the company will begin to lose subscribers. And Netflix relies on the recurring revenue it gets from its existing subscribers. That’s one reason that Netflix should continue to thrive. This is particularly true if the economic recession lasts longer than expected.
But the recession does present a threat. When consumers have to start belt-tightening, it’s the discretionary income that tends to get cut first. And Netflix is a discretionary purchase.
As I see it, at some point everyone who wants to order Netflix will have ordered Netflix. On the other hand, some current subscribers may cancel the service if their personal financial situation deteriorates.
Either way, when a company’s CEO says that investors should expect smaller growth, I tend to listen. It may not be a sell signal, but it’s certainly not a ringing endorsement. With the stock approaching its all-time high, it wouldn’t be the most unthinkable thing to take some profits and wait for the next dip.
Chris Markoch is a freelance financial copywriter who has been covering the market for over five years. He has been writing for InvestorPlace since 2019. As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.
