Netflix NFLX released its third-quarter earnings report on Oct.17. Here’s Morningstar’s take on Netflix’s earnings and stock.
What We Thought of Netflix’s Fiscal Q3 Earnings
- Enthusiasm for Netflix remained high thanks to revenue growth, a very good 2025 outlook, and maybe most importantly, the operating margin remaining fantastic and continuing to expand.
- Subscriber additions finally moderated to a more normalized level after a period of being sky-high, which we attributed to a short-term boost from the crackdown on password sharing.
- In part, margins remain so good because programming costs are below where they were before the Hollywood strikes disrupted new production. These costs should start creeping back up.
- We expect the rates of sales growth and margin expansion to continue moderating, making the stock’s valuation look stretched.
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 $550, which implies a multiple of 23 times our 2025 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.
Read more about Netflix’s fair value estimate.
Key Morningstar Metrics for Netflix
- Fair Value Estimate: $550.00
- Morningstar Rating: 2 stars
- Morningstar Economic Moat Rating: Narrow
- Morningstar Uncertainty Rating: High
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.
Read more about Netflix’s economic moat.
Financial Strength
Netflix is in good financial shape. It ended September 2024 with a net debt/EBITDA ratio under 1.0, with the firm holding about $7 billion in cash and $14.5 billion in total debt. More importantly, we believe the years of cash burn are behind Netflix, giving the firm a good cash cushion after funding its content budget. Even after funding all content costs, including spending that was delayed in 2023 due to actors’ and writers’ strikes, we expect over $6 billion in free cash flow in 2024. We expect free cash flow to grow each year throughout our forecast.
Netflix does not pay a dividend, nor do we expect it to pay one in the near future. It does have a share repurchase program in place, which 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 that arises. We expect no difficulty in rolling over debt as it comes due, and the firm has a well-laddered maturity schedule with relatively little debt maturing over the next four years. Netflix has only $4.5 billion in debt maturing before 2028, with no more than $1.8 billion maturing in any single year.
Read more about Netflix’s financial strength.
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.
Read more about Netflix’s risk and uncertainty.
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 Frank Lee.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
