Netflix Stock: What To Expect From Netflix Inc. (NFLX) Q3 Earnings?

  • Netflix Inc. is scheduled to report its earnings on Oct 17, after market close.
  • Investors will be keenly watching the net subscriber additions metric after the huge miss in Q2.
  • Is Netflix stock a buy ahead of Q3 earnings?
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Netflix Inc. (NSDQ:NFLX)  is scheduled to announce its Q3 2016 earnings on Oct 17, Monday, after the bell. Netflix stock has regained its pre Q2 earnings levels, closing the last trading session at $100.23. Netflix stock had tanked a huge 15%+ following the company's Q2 earnings announcement. The company beat Wall street's earnings estimates by a good 7 cents/per share but still saw the stock price tank. Why? Well, the company missed on the subscriber additions, and by a huge margin. Subscriber numbers will once again, without doubt, be the deal-breaker which could send Netflix stock price soaring or crashing following the upcoming earnings release. Hence, Subscriber numbers will be one of the key numbers to watch out for in addition to top line and earnings growth. Current Wall Street consensus anticipates Netflix to report Q3 revenue of $2.28B and EPS of 6 cents per share, implying revenue growth of 31.2% and a one cent drop in EPS compared to the year ago quarter. Investors should also keep an eye out for the ballooning content costs and the pressure on the company's free cash flows.

Will Subscriber Numbers Disappoint?

The Netflix management had hoped to add 2.5M new subscribers, on a net basis, in Q2. However, the company missed the mark by a good 0.8M or a huge 32% miss. The last quarter was the worst quarter for Netflix, in terms of subscriber additions, over the last 12 quarters. To put this into perspective, Netflix added over 5M subscribers in Q4 15 and Q1 16. So what exactly caused this fall from grace which sent the Netflix stock crashing? The management cited higher than expected churn rate, driven by un-grandfathering of older customers to newer pricing tiers. Quoting from the Q2 earnings release:

Our global member forecast for Q2 was 2.5m and we came in at 1.7m. Gross additions were on target, but churn ticked up slightly and unexpectedly, coincident with the press coverage in early April of our plan to un­grandfather longer tenured members and remained elevated through the quarter.

Will the churn rate driven by un-grandfathering continue to drag the net subscriber adds in Q3? We can arrive at a reasonable conclusion using the Google search trend which the Netflix management had highlighted in the Q2 release. Netflix management mentioned that the higher subscriber churn had coincided with the spike in Google search trends for "Netflix price increase".

Also read: Is Netflix Inc. Stock (NFLX) Headed To $200?

Taking a look at the search trends in the chart above, it is clear that the interest in Netflix price increase has decreased through the quarter. The search interest for Netflix price increase has stayed below 25 through the quarter from a peak of 100 in April.  Consequently, the subscriber churn rate should drop which will aid the company in achieving its subscriber targets.

The management did state that they expected this to be a drag through Q3 and possibly also into Q4. However, the impact might not be as profound as in the previous quarter. Also, the practice of un-grandfathering is a positive in the long run, as it will drive ASPs higher, which should aid topline growth.

The theme of a beat is also supported by a buy rating from Youssef Squali from Cantor Fitzgerald who expects Netflix to report 2.052M international adds and 208K domestic adds, putting the total just north of the management's guidance for 2.3M net subscriber adds.

Rising Content Costs And Free Cash Flows

Investors should also keep an eye on the rising content costs which are also taking a huge toll on the company's free cash flows. Cost of revenues, which include the original programming and content licensing costs rose to $1.47B in the last quarter, a 31% YoY jump. The free cash flow was pushed deeper into the red, coming in at negative 254M, compared to a negative $229M in the year-ago quarter. The company plans to continue with its cash burn with investments focussed on original content, which requires huge upfront investments, as compared to licensed content.

Also read: Netflix Stock: Shift To Original Programming A Moat For Netflix Inc. (NFLX) Investors?

The biggest Netflix bear with a $50 price target for Netflix stock, Michael Pachter from Wedbush securities expects the company to bleed cash for the foreseeable future due to rising content costs. The Netflix bear also expects the quality of the original content to take a hit as the volume of Netflix's original content rises. As reported by Benzinga, Pachter expects higher content costs and slowing subscriber growth to hurt Netflix.

“Netflix expects at least another $1 billion growth in spending in 2017, while meanwhile we think that Amazon Video will up the ante for acquiring new content - driving higher content spend for Netflix combined with slowing subscriber growth,”

Conclusion

Netflix is scheduled to announce its Q3 2016 earnings next week. Investors will keep a close eye on the subscriber numbers after the huge miss in the previous quarter. Wall street expects Netflix to exceed guidance on revenue, EPS as well as subscriber numbers. However, a beat/miss on the subscriber additions could decide the post-earnings move of Netflix stock. Googe search trends imply that Netflix could, in fact, achieve its target of 2.3M subscriber adds for the quarter. A beat here could send Netflix stock price rising. A miss on this metric could send the Netflix stock crashing.

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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