On July 17, Netflix (NASDAQ:NFLX) stock reported disappointing Q2 earnings. Competition in the TV-streaming space is ramping up and Netflix stock is spending a lot of cash to keep its position as an industry leader.
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Netflix stock’s price decline since early July acts as a cautionary tale to tech and media investors. While I would not bet against NFLX shares longer-term yet, the stock is unlikely to make any new highs in the next couple of weeks.
There might be further short-term profit-taking in the stock, potentially offering investors better entry points if they decide to hit the buy button later in the year.
Netflix’s Earnings Release Spooked Investors
In Q2, Netflix missed expectations for revenue and subscriber growth. The streaming-TV company’s quarterly release showed revenue of $4.92 billion, versus Wall Street estimates of $4.93 billion.
With a P/E of 119, Netflix is a growth as well as a speculative stock. Analysts value the stock on an expectation of continued high revenue growth, leading to future profits. Therefore, whenever Wall Street fears the company is failing to meet growth or profit expectations, the stock gets penalized.
Currently, the most critical metric investors pay attention to is NFLX’s subscriber growth. This number needs to remain strong every quarter to justify the high valuation. Netflix disappointed on the quarterly subscriber growth expectations.
In Q2, Netflix added 2.7 million paid members globally. However, Wall Street was expecting 5 million. The streaming company also reported the lowest quarterly subscriber growth numbers in three years.
Netflix lost 126,000 paid subscribers domestically, its first U.S. subscriber loss since 2011. I actually regard this loss as quite important. Investors may want to keep an eye on this metric to see if it becomes a trend.
Unlike many other companies, Netflix does not sell advertising. Instead the company usually pushes through price increases to help increase revenue. However, many analysts believe it is only a matter of time before Netflix starts introducing advertising, at least in some markets.
In simple terms, NFLX stock has to increase revenue fast. And the current business model may not be strong enough to provide that extra revenue.
On a final note, Netflix continues to burn cash. It reported a negative cash flow of $ 518 million — more than double that reported in Q1.
NFLX Stock Faces Increased Competition
Investors are increasingly concerned that Netflix’s market share may start to dwindle in the coming quarters. Netflix’s competitors in the content distribution space include Disney (NYSE:DIS), Amazon (NASDAQ:AMZN), AT&T (NYSE:T), and Comcast (NASDAQ:CMCSA).
It is important to mention Disney’s upcoming November launch of Disney+, the new streaming service from The House of Mouse. It will feature content from various sources, including Disney, Pixar, Marvel, Star Wars. In the U.S., the service, which is likely to appeal to a wide range of viewers, will cost $6.99 a month or $69.99 a year. And the global launch of Disney+ will start in early 2020.
Disney will offer U.S. consumers a bundle of Disney+, ESPN+ and an ad-supported Hulu subscription for $12.99 per month. Incidentally, that would be the same cost as Netflix’s standard subscription plan.
As Disney, the legacy media company, enters the steaming space, Netflix is losing some of its popular shows, such as Friends and The Office, content that originally belongs to its rival platforms, especially to Disney.
In its early years, Netflix bought up content from other networks. However, it has increasingly branched out into original content. In other words, with increased competition, Netflix now has to create more content to keep the subscribers happy. However, content development is a difficult and costly business. Furthermore, in order to promote this new content, Netflix has to also up its marketing costs.
And there are no guarantees that the content will translate into happy or more subscribers. In the Q2 results, Netflix blamed the miss on a weak slate of original programs that brought in fewer sign-ups than expected as well as on price increases in certain countries. In short, it is becoming increasing more costly for Netflix stock to acquire new subscribers.
If Netflix cannot keep up with the aggressive growth assumptions or hike its prices, especially in international markets, then its margins and the stock price would suffer. As these competitors make their mark in the marketplace in the rest of 2019 and 2020, investors may decide to have a wait-and-see attitude, pressuring the recent price gains.
Many analysts are also wondering if the streaming space needs this many services. Could there also be a price war around the corner that could benefit the U.S. consumer, but not necessarily the stock price of Netflix or of its competitors? I do not think Netflix has much pricing power in this competitive environment.
Netflix Stock’s Shorter-Term Technical Analysis
Netflix is a momentum stock. Therefore, its price volatility is high. Its 52-week range has been $231.23-$386.80.
On July 17, before reporting Q2 earnings, NFLX stock closed at $362.44. The next morning, it gapped down to open at $323.76. On Aug. 15, it saw a recent low of $288. As a result, the technical outlook of NVDA stock has been damaged. And its short-term chart still looks weak.
On a given day, it is usually a battleground between long-term investors and short-term traders. I believe the stock market will continue to be volatile and possibly weak in the coming weeks. Therefore, sizeable daily swings in NFLX stock are likely to continue.
NFLX stock is currently trading in a tight range and hovering below $300. Thus, it likely to break out of the range and make a new leg soon. Although the new leg could be either up or down, I expect NFLX shares to decline first toward $275 and then further toward $250.
If you believe in the fundamental bull case for Netflix stock, you might consider waiting for a better time to go long, such as between $250-$275 level. Expect nearer-term trading in Netflix stock to be choppy at best.
Short Interest and NFLX Stock
As part of short-term sentiment analysis, investors may also monitor the extent to which stocks are shorted. In other words, they follow the ratio of short positions that are open and yet to be covered. Two investors may look at the same data and have differing views. I tend to use the number as a contrarian indicator.
For example, if more than 20% of a stock’s float (available shares) are shorted, then even a small rise in its price could actually become a powerful short squeeze and propel the stock much higher.
At this point, 5.2% of NFLX’s shares are shorted. So while there are plenty of traders who have shorted Netflix stock, not enough shares of NFLX are being shorted to set the stage for a massive short-squeeze rally. I’d argue that in the coming weeks the current level of short-selling in NFLX stock may increase and put further selling pressure on the shares.
The Bottom Line on Netflix Stock
Stocks suffer during times of uncertainty, and the current global environment, as well as the changing fundamentals in the streaming space, offer plenty of questions. Netflix has a strong story and it remains a long-term play. However, there might be further weakness in the NFLX stock price in the near term that investors should anticipate.
In the coming months, I expect the NFLX stock price to be a battleground between investors and traders. While long-term investors would like to see Netflix go and stay over the $350 level, traders are likely to keep the range between $275 and $325.
I do not currently expect much upside potential in NFLX stock given the valuation levels as well as the market fundaments. Only when Netflix management offers a sustainable competitive advantage, the stock is likely to write new growth story.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.