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Wednesday, December 7, 2022

Netflix Stock Viewing Downside on the Horizon

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As one of the pre-eminent growth plays on the NASDAQ exchange, Netflix (NFLX) has long been included in the “FAANG” grouping of superstar growth stocks that have absolutely skyrocketed over the past decade. Indeed, it’s difficult to argue with the historical performance of Netflix. The company has been better than a 5-bagger for investors over the past five years. Those who have simply bought this stock and forgotten about it have done very well for themselves in the past.

The company’s business model has continued to be cheered by the market. Indeed, high levels of spending on content have resulted in continued subscriber growth and top-line growth that’s hard to ignore.

That said, from a bottom-line perspective, Netflix leaves many investors wanting. Let’s dive into why this stock may see some outsized downside, should rising inflation concerns and higher interest rates take growth stocks on a rough ride in the coming quarters.

Financials Look Better than Ever, But Are These Numbers Sustainable?

Looking at Netflix’s fundamentals, the long-term historical performance of this company’s overall business hasn’t really been great.

Netflix’s business model relies a great deal on heavy content spending to drive subscriber growth. Accordingly, Netflix has been burning a lot of cash to grow, something that has required the company to take on large sums of debt.

In fact, from 2016 to 2019, Netflix’s debt issuances increased rapidly each and every year. The company went from issuing $1 billion in debt in 2016 to nearly $4.5 billion in 2019. Then the pandemic happened.

This past year, Netflix had to raise “only” $1 billion in debt. In other words, its spending dropped back down to 2016 levels.

Part of this was due to higher revenues spurred by increased demand for in-home entertainment, brought about as a direct result of the pandemic. Some of this was due to content production slowing during the pandemic. Whatever the reason, the corresponding improvement in Netflix’s unit economics as a result of the pandemic pushed the company into positive cash flow territory.

Indeed, from this perspective, things look decent for investors in NFLX stock. In 2020, the company posted its first positive year in terms of free cash flow since 2011. Approximately $4.38 in free cash flow was generated per share in 2020. In trailing 12 month terms, the number is $5.57.

Accordingly, many investors in NFLX stock may be emboldened by this fact. After all, the value of any stock is directly related to the discounted future free cash flows a given company generates. The fact that Netflix is now in the black in this key metric ought to make this stock an easier one to forecast.

Not so fast.

Many investors are of the view that the recent free cash flow performance of Netflix is temporary. There are a couple of factors driving this view.

First, Netflix’s recent subscriber growth this past quarter fell way short of the company’s own estimates, as well as consensus analyst estimates. Netflix posted gains of only 4 million new subscribers in the first quarter, well-short of the company’s guidance of 6 million new subscribers, and the consensus estimates of 6.3 million. Thus, there’s a lot of credence being given to the idea that the pandemic provided a one-time boost to free cash flow that may be unsustainable.

The second annoying fact investors will need to consider is that as the economy reopens, film studios and content producers will once again kick it into high gear to make up for lost time. With many film crews shut down for a good portion of this past year, ramping up production on Netflix’s end will undoubtedly result in more capital spending. Accordingly, many investors expect Netflix to return to the bond markets in a big way this coming year, pushing down free cash flows into negative territory once again.

Additionally, even basing Netflix’s valuation on its trailing 12-month free cash flow numbers, this is a stock that’s trading at roughly 90-times free cash flow. That’s insanely expensive. Even if one were to consider the idea that these free cash flow numbers could potentially be sustained (which may believe is highly unlikely due to the one-time boost the pandemic provided), Netflix is expensive. If cash flows fall back to earth in the coming quarters, there’s no telling how steep of a correction investors in NFLX stock could see.

What Analysts Are Saying About NFLX Stock

According to TipRanks’ analyst rating consensus, NFLX stock comes in as a Moderate Buy. Out of 35 analyst ratings, there are 26 Buy recommendations, 6 Hold recommendations, and 3 Sell recommendations.

As for price targets, the average Netflix analyst price target is $611.27. Analyst price targets range from a low of $342.00 per share to a high of $720.00 per share.

Bottom Line

From a fundamentals perspective, Netflix appears to be the most richly-valued FAANG stock on the market right now. Accordingly, those concerned about headwinds for growth stocks may want to direct their attention toward any of the other FAANG names presently.

The view that Netflix’s recent outperformance is a one-time event appears to have taken hold in the market. This stock has traded within a relatively narrow band for the better part of the past year. In a best-case scenario, that’s where this stock is likely to trade for some time.

Disclosure: Chris MacDonald held no position in any of the stocks mentioned in this article at the time of publication.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.

The post Netflix Stock Viewing Downside on the Horizon appeared first on TipRanks Financial Blog.

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