Netflix (NFLX - Free Report) is one of those stocks that you look at now and say to yourself if only I would have bought 2 years ago, “I knew this stock would do well” with that 20/20 hindsight all investors suffer from (NFLX vs. S&P 500 2 year performance below). Currently trading at $360, we now need to reevaluate our positions (or lack of) in NFLX and assess if this seemingly exponential growth is going to continue. This behemoth in the subscription streaming services space is going to be facing some fierce competition for market share. Amazon (AMZN - Free Report) Prime Video has really upped its game in original content, Hulu has been able to gain exclusive content that makes it a must-have for some, and Apple (AAPL - Free Report) just announced yesterday that it’s releasing its own subscription streaming service.
Netflix has just announced it will be raising the prices of its subscriptions 13%-18%. This increases makes the premium HD subscription a $192 a year expense. A survey done by The Diffusion Group asked current subscribers about how they would react to a $1, $3 and $5 increase in subscription price. From just a $1 increase in price, the survey showed that 16% of customers would either downgrade or cancel. A $3 increase would cause 38% of subscribers to downgrade or cancel, and a $5 increase would cause even more devastation to Netflix. These stats should only be taken with a grain of salt because what subscribers say and what they do are two different things. But none the less this consumer sentiment is very interesting considering that Amazon Prime costs consumers only $120 annually and consists of a lot more than just video streaming. I’m not saying that Amazon Prime Video holds a candle to the content on Netflix but consumers want value and for the value, Amazon Prime offers more.
Netflix has recently relied heavily on original content to bring in customers, and it has worked. This original content is critically recognized, with 14 Oscar nominations winning in 4 categories just this year. This original content is burning up a ton of free-cash-flow though. The question we need to ask is when credit market aren’t as flexible and cash isn’t as readily available will this strategy still be successful?
Netflix is stockpiling as much original content as possible right now when the credit markets are good. It seems that they have a new series and/or movie ever week and viewers don’t have close to enough time to watch all the trendiest content. When credit markets begin to deteriorate Netflix will still have all the original content that subscribers hadn’t got to yet. Netflix knows that the return on investment is substantially higher on original content. Being able to push out as much quality content as possible when cash is easy to come by is a very profitable strategy in the long run.
Netflix is currently trading at 80 times earnings which means there is a considerable amount of growth priced into this stock. Amazon is only trading at 60 times earnings and Apple trading at only 16 times earnings. Is the growth priced into NFLX attainable in the near term? The answer is probably not. It will take years for this valuation to come to fruition. Top and bottom line growth have been relatively stable. The real story comes from the number of added subscribers which has been substantial over the past 3 years from 78 million in the beginning of 2016 to about 140 million by the end of 2018 (according to NFLX investor relations).
This consistently sizeable growth in Netflix’s subscriber base is what’s really driving the expensive valuation combined with their high margin original content. I still believe that the valuation is a little too high to be confident in the trade, but would look to buy this stock sub $300 if the opportunity arises - NFLX current Zacks Rank #3 (Hold).
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