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Shares of leading streaming platform Netflix (NASDAQ: NFLX) have lost around 10% in market value in the last week and it's now trading 14% below record highs. Netflix has underperformed the broader markets this year after the stock crushed expectations in 2020. The COVID-19 pandemic acted as a tailwind for streaming companies as economic lockdowns meant entertainment options were limited. People were confined to their homes which accelerated subscriptions for streaming services at a rapid clip.
However, Netflix stock has now lost momentum year to date, and let’s see why it experienced a pullback last week.
Netflix adds 4 million subscribers in Q1
Netflix reported its Q1 results on April 20 and disclosed it added 4 million new subscribers in the March quarter. This was significantly lower than management estimates of 6 million net additions. Netflix sales were up 24% year over year at $7.16 billion while earnings more than doubled to $3.75 from $1.57 in the prior-year period. While Netflix’s revenue figures were as per expectations, its bottom-line surpassed estimates of $2.97 per share.
Netflix has forecast revenue to grow by 19% annually to $7.3 billion in Q2 while adjusted earnings are expected to double again. However, the company confirmed it estimates subscriber additions to decelerate to 1 million in the June quarter.
In 2020, Netflix added a record 40 million new subscribers taking its total account to over 200 million at the end of the last year. However, the pandemic also meant that content production slowed down significantly due to lockdown restrictions pushing back multiple title launches and season premiers to the second half of 2021 which impacted customer additions in Q1.
While Netflix met revenue estimates and beat earnings forecasts in the March quarter, investors were worried about the slowing pace of subscriber growth in the near term, dragging the stock lower last week.
Strong operating margin and cash flow
While Netflix has failed to impress in Q1, investors should note that total subscribers were up 14% year over year. Its impressive performance in 2020 has allowed the company to generate positive cash flows, showcasing its resilient business model that can also be considered recession-proof.
After several years of grappling with negative cash flows, Netflix’s free cash flow stood at $692 million in Q1. Its robust top-line growth also allowed the company to report an operating margin of 27% and an operating profit of $2 billion in the March quarter.
While Netflix will ramp up spending on content production in the upcoming months, it expects to achieve break-even cash flow this year. Netflix will be spending close to $17 billion in creating original content in 2021 and the company’s management confirmed it is close to being free cash flow on a consistent basis.
Netflix’s authorized share buyback program of $5 billion indicates the management team is bullish on the company’s cash-generating ability going forward. As Netflix expands and gains traction in other international markets, its easily scalable business will lower customer acquisition costs and allow it to increase subscription fees and improve its cash flow position as well.
What next for Netflix investors?
While Netflix stock has trailed the market in 2021, the company remains a market leader in the streaming industry. Yes, it will be impacted by rising competition from tech giants including Apple (NASDAQ: AAPL), Disney (NYSE: DIS), Amazon (NASDQ: AMZN), and AT&T (NYSE: T). But the streaming space has enough room for multiple players to co-exist. Further, Netflix believes the total number of subscribers it can target is around 800 million, which suggests the company can continue to grow top-line in 2021 and beyond.
Netflix is valued at a market cap of $225 billion. Analysts expect the company to grow revenue by 19% to $29.8 billion in 2021 and by 15.4% to $34.4 billion in 2022. Comparatively, its earnings are forecast to grow at an annual rate of 45% in the next five years. This suggests Netflix stock is trading at a forward price to sales multiple of 7.5x and a price to earnings multiple of 48.6x which is reasonable considering its growth estimates.
Wall Street analysts tracking the stock have a 12-month average target price estimate of $610 for Netflix which is 20% higher than its current trading price.
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