Netflix NFLX is set to release its fourth-quarter earnings report on January 23, 2023, after the close of trading. Here’s Morningstar’s take on Netflix’s earnings and stock
What to Watch for In Netflix’s Q4 Earnings
Ad-Free Appeal: The biggest items of interest concern Netflix’s ad-supported subscriptions. Most notably, we’re looking to see whether net subscriber additions are again very high and driven by the ad-free tier.
Ad-Supported Subs: We’ll also be interested to hear where the firm is with generating revenue from advertisers on ad-supported subscriptions. Has ad revenue been material to the top line yet? How far away are we from ad-supported subscribers being as valuable as traditional subscribers?
Password Sharing: Finally, it will be interesting to hear where the firm thinks it is on its password-sharing crackdown. This should give insight into how much longer (if at all) the resultant boost in subscriber additions will last.
Fair Value Estimate for Netflix
With its 2-star rating, we believe Netflix’s stock is overvalued compared with our long-term fair value estimate.
We’ve raised our fair value estimate of Netflix to $410 from $350, implying a multiple of 26 times on our 2024 earnings per share forecast. We project high-single-digit average annual revenue growth over our five-year forecast and believe there’s room for margin expansion as international markets mature and benefit from greater scale.
Key Morningstar Metrics for Netflix
Fair Value Estimate: $410.00
Current Price: $485
Morningstar Rating: 2 stars
Morningstar Economic Moat Rating: Narrow
Morningstar Uncertainty Rating: High
Where Are New Subscribers Coming From?
We expect subscriber growth to come mostly from international markets. After a jump in household penetration in 2023, which we attribute to the company’s crackdown on password sharing, we expect new member growth in the United States and Canada, or UCAN, to slow significantly in 2024. Over our forecast, we project UCAN member growth to track the rate of growth in household formation, about 1%-2% annually. This will imply a household penetration rate in the low-to-mid-50% range throughout our forecast.
We believe rising competition and higher prices will keep Netflix from reaching a greater percentage of households. We expect UCAN average revenue per user to rise at a low-to-mid-single-digit rate each year. The firm should continue raising prices at least every two years, but we also expect a bump in advertising revenue. Netflix began selling ad-supported subscriptions in 2022, but we think it has not yet reached its potential, leaving room for upside.
Netflix – Narrow Moat Rating
We assign Netflix a narrow moat based on intangible assets and a network effect. Netflix has two advantages that set it apart from streaming video peers. First, it has no legacy assets that are losing value as society transitions to new ways of consuming entertainment at home, allowing it to put its full effort behind its core streaming offering.
Second, it was the pioneer in its industry, providing it a big head start in accumulating subscribers and moving past the huge initial cash burn necessary to build a successful streaming service. This subscriber base was critical in creating a virtuous cycle for Netflix that we doubt can be breached by more than a few competitors, which is what we think would be necessary to dampen its ability to earn excess economic returns for the foreseeable future.
Ultimately, having a successful streaming service is all about continually offering a depth of appealing content at a price point that consumers deem reasonable. The industry is not necessarily a zero-sum game, as customers can always add incremental subscriptions. But budgets are finite, so practically speaking, we expect only a handful of streaming services to consistently hold very large customer bases, which we think will be necessary to continue funding content investment.
Risk and Uncertainty
Our Uncertainty Rating for Netflix is High, based largely on the evolving streaming media landscape and the additional competition Netflix faces.
In our view, Netflix’s tremendous success is due to it being a first mover in the streaming industry, as well as how it successfully adapted its business model to where the industry was going while its media peers were largely still focusing on their legacy businesses.
The landscape has now changed, as nearly every major media company is promoting a standalone streaming service. Also, Netflix is more focused on profitability and cash generation than it was in its infancy, meaning its prices have risen substantially over the past several years. Customers now have other choices for streaming subscriptions and the price they pay for Netflix is no longer an afterthought, creating uncertainty around the firm’s ability to attract and retain customers.
As competing streaming businesses mature, their parent companies may bundle their services together (with or without Netflix), or they may offer these services as add-ons for pay-TV subscribers who receive their linear channels, a foothold Netflix doesn’t currently have. These factors make it possible that Netflix will have a tougher time growing its subscriber base or generating as much revenue per subscriber.
