• Fair Value Estimate: $500.00
• Morningstar Rating: 2 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

Earnings Release Date

Thursday, Oct. 17, 2024, before the start of trading.

What to Watch for in Netflix’s Q3 Earnings

• We’ve been waiting for a slowdown in subscriber growth as the firm gets further from its paid sharing subscription option and the beginning of its password-sharing crackdown.
• We expect revenue growth will be great, but we want to hear whether advertising is meaningfully contributing yet, and whether the company has an update on the ad-supported subscriber base. We believe this is the likeliest source of future revenue growth.
• We expect margins and profit will again be great, but we will look for any clues as to whether margins can expand further and what the outlook is for free cash flow now that content spending is back in full swing and the firm has begun to license more live sports and sports-adjacent events.

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 of $500, which implies a multiple of 25 times our 2024 earnings per share forecast. We project high-single-digit average annual revenue growth over our five-year forecast, and we believe there’s room for margin expansion, as international markets mature and benefit from greater scale.

We expect subscriber growth to come mostly from international markets over the long term. After a jump in household penetration that began in 2023, which we attribute to the firm’s crackdown on password sharing and its ad-supported subscription alternatives, we expect new member growth in the United States and Canada (UCAN) to slow significantly in 2025. Over our forecast, we project UCAN member growth of about 2% annually, only marginally exceeding the rate we expect for household formation. We project UCAN average revenue per member to rise at a mid-single-digit rate each year. We expect the firm to continue raising prices at least every two years, but we also anticipate a material bump from advertising revenue. Netflix began selling ad-supported subscriptions in 2022, but it has not yet reached its selling potential for ads within that service, leaving room for upside.

Penetration rates in Europe, the Middle East, and Africa (EMEA), Latin America, and Asia Pacific (APAC) significantly trail those in the US, so we expect much more room for subscriber growth. As Netflix continues to create more country-specific content and find the right pricing strategy, we believe penetration can rise, though we don’t expect most countries to get close to the penetration rates seen in UCAN. We believe subscriber growth in APAC can grow at a low-double-digit rate throughout our forecast, driven by growth in India, while we project Latin America and EMEA subscriber bases to grow in the mid-single-digits annually.

Netflix Economic Moat Rating

We assign Netflix a narrow moat based on intangible assets and a network effect. Two advantages set the firm apart from its peers. First, it has no legacy assets that are losing value as society transitions to new ways of consuming entertainment at home, letting it put its full effort behind its core streaming offering.

Second, Netflix pioneered its industry, providing a big head start in accumulating subscribers and moving past the huge initial cash burn needed to build a successful streaming service. This subscriber base was critical in creating a virtuous cycle that we doubt can be breached by more than a small number of competitors.

Ultimately, having a successful streaming service is all about offering customers a continuing depth of appealing content at a price point consumers deem reasonable. The industry is not necessarily a zero-sum game, as customers can always add incremental subscriptions. But consumer budgets are finite, so practically speaking, we expect only a handful of streaming services to consistently hold large customer bases, which we think will be necessary to continue funding content investments.

Netflix Financial Strength

Netflix is in good financial shape. It ended 2023 with a net debt/EBITDA ratio under 1.0, holding about $7 billion in cash and $14.5 billion in total debt. More importantly, we believe the years of cash burn are behind the firm. Even after funding all content costs, including spending that was delayed in 2023 due to the actor and writer strikes, we expect over $6 billion in free cash flow in 2024.

The firm does not pay a dividend, nor do we expect it to do so soon. It has a share repurchase program that will provide one outlet for some cash flow. We don’t expect acquisitions, as those have never been a part of Netflix’s strategy, but we believe it has plenty of flexibility to pursue any attractive opportunity.

Netflix Risk and Uncertainty

Our Uncertainty Rating for Netflix is High, largely based on the evolving streaming media landscape and the additional competition the company now faces. In our view, Netflix’s tremendous success is due largely to it being a first mover in the streaming industry and successfully adapting its business model while peers largely focused on their legacy businesses.

Now, nearly every major media company is promoting a stand-alone streaming service. Netflix is more focused on profitability and cash generation than it was in its infancy, meaning prices have risen substantially for consumers 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 users.

NFLX Bulls Say

• Netflix has created many hit shows exclusively available on its platform that have attracted a massive customer base. The firm’s advantage in cash generation means this virtuous cycle will likely continue.
• Advertising-supported subscriptions will open Netflix to a new base of subscribers and a potentially substantial new source of revenue.
• Netflix has significant room to grow in international markets, where it has already shown promise with local content.

NFLX Bears Say

• Netflix is beginning to face competition that it has not had to deal with in the past. As consumers have more options for quality streaming services, it’s more likely that the platform could get cut out of some consumer budgets.
• Netflix’s US business is mature, with a high penetration of total households, meaning price increases need to be the main source of growth, and consumers may not accept higher prices.
• Creating attractive content is always a gamble. The allure of Netflix’s service will always be tenuous, dependent on continually producing hits.

This article was compiled by Renee Kaplan.