Rising Margins, Ad Growth To Drive Netflix’s Q2 Results, But Stock Is Expensive At $670

Netflix (NASDAQ:NFLX) stock has had a pretty good year, rising by almost 38% year-to-date as the company successfully navigated a brief subscriber decline post-Covid-19. This compares to rival Disney (NYSE:DIS), which has gained about 8% over the same time frame. Netflix is poised to report its Q2 FY’24 results on July 18, reporting on a quarter that is likely to see the company continue to expand its customer base led by its ad-supported plans and crack down on password sharing. We expect earnings to come in at about $4.75 per share, marginally ahead of consensus estimates, while revenues are likely to come in at about $9.60 billion, slightly ahead of consensus estimates, rising 16.5% compared to the last year. See our analysis of Netflix earnings preview for a closer look at what to expect from Netflix earnings.

Netflix net additions are to be sequentially lower in Q2 on account of typical seasonality. However, the company should continue to benefit from its ad-supported tier which is enabling it to attract more price-sensitive customers with a price of just $7 per month in the U.S. This tier had a total of 40 million users as of mid-May 2024, up from about 23 million in January and Netflix has indicated that the ad-supported services represented about 40% of all its signups in the last quarter in markets where they are offered. Moreover, the ad-supported plan is expected to generate more revenue per user than some of Netflix’s ad-free plans as incremental ad revenue more than offsets the discount offered on the ad tier. Over Q1, Netflix said that average revenue per membership rose to 1% year over year and by about 4% adjusted for foreign exchange effects. Netflix has indicated that the metric is poised to rise over Q2 as well as adjusted for foreign currency. Separately, Netflix’s crackdown on password sharing is also likely to help drive up its subscriber numbers to an extent.

Netflix has been increasingly focusing on boosting its margins. For Q2, operating margins are guided at 26.6%, marking an increase from 22.3% in the year-ago quarter. Growth is being driven as revenue growth outpaces operating costs due to economies of scale and also potentially lower content spending growth. Netflix’s continued price increases are also likely helping profitability.  That said, margins are likely to trend slightly lower on a sequential basis.

Now NFLX stock has shown strong gains of 25% from levels of $540 in early January 2021 to around $675 now, vs. an increase of about 45% for the S&P 500 over this roughly 3-year period. However, the increase in NFLX stock has been far from consistent. Returns for the stock were 11% in 2021, -51% in 2022, and 65% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that NFLX underperformed the S&P in 2021 and 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for other heavyweights in the Communication Services sector including GOOG, META, and TMUS, and even for the megacap stars TSLA, MSFT, and AMZN.

In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could NFLX face a similar situation as it did in 2021 and 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

Although we think that Netflix stock could move slightly higher if it beats earnings, we believe the stock is overvalued. At the current market price of about $674 per share, Netflix trades at almost 40x forward earnings, which is a bit pricey in our view. While Netflix’s recent performance has been strong, consumer spending growth appears to be slowing down, with the metric rising by about 0.2% in April after a rise of about 0.7% in March. Moreover, the unemployment rate in the U.S. has also seen a bit of an uptick coming in at 4% in May, up from 3.9% in April. These trends could weigh on players such as Netflix who are dependent on strong consumer confidence. Netflix could also see subscriber growth cool, as the impact of its accelerated subscriber ads coming from the twin impact of the password-sharing crackdown and ad-supported tiers is likely to eventually normalize, reducing momentum for the stock.  We have a $528 price estimate for Netflix, which is about 22% below the market price. See our analysis Netflix Valuation: Expensive or Cheap for more details on what’s driving our price estimate for Netflix. Also, check out the analysis of Netflix Revenue for more details on how Netflix revenues are trending.

[1] Returns as of 7/2/2024
[2] Cumulative total returns since the end of 2016

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