Netflix (NASDAQ:NFLX) stock has been a front-runner among the winners of 2013. The stock has gained a whopping 312% last year, leading the list of last year’s highest gaining internet stocks. The stock has seen a 10% pullback in price since January 1st, 2014. The stock saw a significant fall of 2% in the regular trading session on Jan 15th, 2014, following the news of US court of appeals decision to overthrow the FCC’s (federal communications committee) net neutrality regulation. If you are a long term Netflix investor, now would be the right time to step back and take a relook at your Netflix investment. Does the latest pullback present an entry point for the long term investor or is it just the beginning of a bigger correction, the Netflix stock price having run-up alarmingly in the last year? Today we shall cover the various facts which will impact the company’s fundamentals over the coming quarters and their implications for an investor.
Netflix: 2013 performance
The last year saw significant movements at Netflix, be it in the fundamentals of the company or its stock price. We would like to highlight the company’s yearly performance in 2013 before moving on to our expectations in 2014. The chart below displays the change in the company’s viewer composition in 2013.
It can be seen that the growth in international members is faster than the growth in domestic members as the company entered into new countries. Netflix service is currently present across 41 countries and will continue its geographical expansion into 2014.
We shall now take a look at the fundamental factors of Netflix. The table below summarizes the revenue and earnings changes at Netflix over the last year.
Netflix Fundamental Drivers
|In millions USD, except per share data||Q4 2012||Q1 2013||Q2 2012||Q3 2013||Q4 2013 guidance, midpoint||Q4 2013, YoY change|
|Free Cash Flow||-51||-42||13||7|
Based on numbers reported in the company’s Q3, 2013 earnings report
It can be seen that the company saw significant improvement in earnings and revenues during 2013. Based on the midpoint of Q4 2013 guidance, the company will register a full year earnings growth of close to 350% on a revenue growth of 21% - 22% (revenue growth based on our expectations for Q4, 2013). The significant improvement in earnings will be a welcome relief to investors. However, the company will still have to grow earnings substantially in order to justify the current valuation levels of the stock.
Netflix Q4 2013 and FY 2014
Netflix is expected to report its Q4 2013 and FY 2013 earnings on Jan 22nd. As an investor it will be important to look at a few numbers beyond the revenue and earnings growth. Apart from the earnings, we will be keeping a watch on the subscriber numbers and the overall profit margins of the company. The subscriber numbers will assume greater importance over the coming quarters, in light of the recent victory of Verizon over the FCC. The judgement by the US court of appeals could lead to differential pricing for streaming service providers like Netflix, leading to an increase in the operating costs and resulting in long term pressure on profit margins.
On the positive side, Netflix’s early commitment to in-house developed content has helped the company improve its profit margins and also enabled it to create a diversified content portfolio. The diversified content portfolio is a competitive strength which could help Netflix retain users in case the company resorts to marginal price increases to offset higher operating costs.
We expect the company to report numbers at the higher end of Q4 2013 estimates and continue its good performance over the coming year. However, any significant change in the cost structure will put the already low profit margins under extreme pressure. Netflix’s in-house developed content and variety in its portfolio are couple of factors which lend a competitive edge to the company in an otherwise commoditized industry. We expect the company’s revenues to be driven by continued subscriber growth, as it expands geographically and brings greater variety and choice in its product offering. However, at its current levels, the stock is trading at a 1-yr forward P/E of 79.1 and a 2-yr forward P/E of 43.5 based on estimates of the company’s earnings over the next two years. Though we see the company as fundamentally strong and heading in the right direction overall, we see it as a highly risky investment at its current price levels, as the price seems to have run far ahead of the company’s fundamentals. Check back to read our take on the company’s Q4 2013 earnings numbers.
To see Netflix’s current stock price, please click here: (NASDAQ:NFLX)