- After plunging 35% below its December high, Netflix stock has been rallying strongly again.
- Investors are worried about Netflix's slowing customer growth in its domestic market.
- Netflix stock could go on to make good gains in 2017 after the company becomes solidly profitable.
After plunging 35% below its November high, Netflix (NASDAQ:NFLX) stock is now up 10.4% over the past one month, that has investors hoping that the battered stock is finally out of the dog house. Netflix stock is still down 14% YTD, a far cry from 2015 when it finished the year as the best performer in the S&P 500 with a gain of 134%.
6-Months Netflix Stock Returns
So what is dogging the stock? For the record, growth stocks such as Netflix outperformed value stocks in 2015. In the current year, the tables have turned with growth stocks being badly hammered. In the case of Netflix, investors seem to have a genuine reason for shunning the stock - slowing growth. After posting 10 straight years of impressive growth, it’s beginning to appear as if growth at Netflix is going to increasingly become an uphill battle. Netflix’s domestic net adds have started slowing down. During Q4 2015, Netflix’s net additions in the U.S. clocked in at 1.56M compared to 1.90M during Q4 2014. Further, the company said that it expects Q1 2016 net additions in the U.S. to clock in at 1.75M vs. 2.28M in Q1 2015. The slowdown in new customer adds in the U.S. market for Netflix is inevitable. After all, the company has already covered half of the potential domestic market.
Further, Netflix said that it expects churn to increase during the second and third quarters when many of its older members on a 2-year HD grandfathered plan paying $7.99 will have an option to continue paying the same but be downgraded to an SD plan, or jack up their subscription to $9.99 to continue on a HD plan.
To make matters more complicated for Netflix, the slowdown in domestic customer growth has not been accompanied by profits. Netflix’s growing content costs and international expansion plans are to blame for the company’s lack of profits. Netflix expects to spend $5B in content costs in 2016, about double what it spent in 2015. Netflix has to contend with intense competition from rivals like Hulu, which is backed by four of the six largest cable companies in the U.S., and Amazon (NASDAQ:AMZN) when bidding for content from media houses. Hulu in particular has become a thorn in Netflix’s flesh, with cable companies increasingly preferring to license content to Hulu instead of Netflix due to Hulu’s better rates.
Meanwhile, Netflix has been expanding to international markets at a rapid clip which inevitably means higher content cost and infrastructure cap-ex. During the fourth quarter, Netflix domestic segment posted gross profit of $379M, compared to $(109M) for the international segment.
When these worries are coupled with Netflix’s seemingly absurd PE ratio of 350, you begin to see why investors have been giving Netflix shares a wide berth.
But Netflix stock still stands a big chance to bounce back.
A healthier bottom line could turn things around for Netflix
For a long time, Netflix has operated on thin margins due to the company’s primary focus on expansion, first in the U.S. and more recently in international markets.
Now that that's done, with its expansion into 130 new markets, Netflix will have a good chance to begin consolidating its position in its new markets. So while there is still work to do to tailor-make content for certain international markets, Netflix has already done the heavy lifting. Earlier in the year, Netflix discussed its long-term plans where it said, among other things, that it sees itself becoming solidly profitable beginning 2017.
So, while there are not many catalysts that might prop up Netflix stock in 2016, strong growth in profits starting 2017 could prove to be the turning point for the shares. Long-term investors should therefore continue holding the shares. Netflix stock might still be in the dog house, but might not remain confined in it for long.