Netflix’s NFLX very strong third-quarter sales growth was largely assured, considering the huge increase in subscribers over the past few quarters. Still, we were impressed at how much further margins expanded beyond the huge rise already this year.
Morningstar Metrics for Netflix Stock
• Fair Value Estimate: $550.00
• Morningstar Rating: 2 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High
Netflix also offered an initial sales and margin outlook for 2025 that portends less of a deceleration than we anticipated following a blockbuster 2024. The third quarter showed the slowdown in subscriber growth that we’ve been expecting, but Netflix has other areas of opportunity to continue boosting its financial performance.
After adjusting our projections, we’re raising our fair value estimate to $550 from $500. Still, while the firm’s persistent near-term strength exceeds our expectations, and we expect Netflix to remain well ahead of competitors, we think the market is extrapolating recent amazing results too far into the future. We think some markets are approaching saturation, and although we see opportunities for Netflix to enhance revenue per subscriber, we don’t think those are so big as to offset decelerating subscriber additions. We also expect much more moderate margin expansion than has occurred in 2024 because we expect Netflix will increase content spending at a similar rate as sales to help maintain its wide lead over competitors and strengthen its moat, which we rate as narrow today.
Third-quarter sales grew 15% year over year, and the firm added another 5 million subscribers globally, including about 700,000 in the United States and Canada. While solid, both figures were the fewest since the first quarter of 2023, and we think they now put Netflix on more of a normalized pace after the firm added about 40 million global subscribers and 9 million UCAN subscribers over the prior four quarters. We expect greater advertising monetization and price increases to contribute more to growth over time, but in the third quarter, average revenue per subscriber was flat globally.
Netflix Price Rises Incoming?
Management’s initial 2025 outlook calls for 10%-12% sales growth after the 15% it expects to achieve in 2024. Subscriber growth during 2024 should underpin a big chunk of that growth, but we think price increases will also help drive average revenue per subscriber higher after that metric flatlined this year. The firm recently raised prices in a few countries in Europe and Latin America, and in Japan, and it announced increases in Spain and Italy will take place this week. With the firm approaching the three-year anniversary of its last price increase on the standard plan in the US, we suspect some US price increases may also be on the horizon.
The firm is still not monetizing its ad-supported tier to the extent that it’s a big contributor to revenue growth, but it continues to progress in expanding that user base. The ad-supported subscriber base grew 35% in the quarter, and we estimate the ad-supported tier now makes up about 25% of global subscribers. While Netflix is well on its way to achieving the necessary scale and ad inventory it needs to attract advertisers, management still has a multiyear timeline for when advertising will become a material portion of total revenue.
The third-quarter operating margin reached almost 30%. The firm is on pace to expand the operating margin by more than six percentage points in 2024 to about 27%. Management expects further expansion in 2025 and said it has a significant runway to more expansion beyond that. We expect further margin expansion to develop slowly.
Margins have held up better than we expected in 2024 in the wake of the 2023 Hollywood strikes that slowed the launch of new programming, but we still expect content costs to rise soon. New cash content spending has ramped back up, 30% higher year to date versus the first three quarters last year, and the firm will soon have the costs associated with its forays into live sports programming. However, content amortization expense, which hits the income statement, was only $3.7 billion, a quarterly amount that has stayed relatively flat over the past two years. We expect a rise in content amortization to largely offset the gains we expect from price increases and greater operating leverage, so we expect a slower continuing expansion of margins over the next few years.
