Tech behemoth Netflix, Inc. (NFLX - Free Report) is set to report third-quarter earnings after market close on Oct 16. Shares of the video streaming company have gained 6.2% so far this year, less than the Broadcast Radio and Television industry’s rally of 8.9%. What’s more, such gains are almost 30% below the all-time high reached in 2018.
Much of this year’s weakness was led by the company’s lower-than-expected subscriber growth in the second quarter and concerns about tough competition from streaming heavyweights like The Walt Disney Company (DIS - Free Report) , Apple Inc. (AAPL - Free Report) and Amazon.com, Inc. (AMZN - Free Report) .
Subscriber Growth Decelerates
Netflix reported that U.S. subscription count declined by 126,000 at the end of the second quarter compared to the first. Barron’s added that market pundits were expecting as many as 352,000 domestic subscription additions. In fact, it was the first drop in net U.S. subscriptions since 2011.
International memberships also took a beating, falling 40% short of the company’s estimates. Overall, Netflix was able to add only 2.7 million net new subscribers, less than the forecasted 5 million.
For argument’s sake, Netflix still is a dominant provider of video streaming content. After all, it has nearly 60.1 million domestic subscribers and 91.5 million international members. But such slowing growth in new subscribers is an initial warning that competition is heating up and it may take a toll on the company’s third-quarter earnings results.
Lest we forget, by the end of this year, Disney and Apple are set to launch their own streaming platforms. This might imply that Netflix will be losing its right to stream two of its most popular shows — The Office and Friends.
And while Netflix boasts of its large subscriber base, we shouldn’t forget the huge debt it has shouldered to fuel the growth. Over the last two years, the company’s debt has expanded from $4.8 billion to $12.6 billion. But that may not be a big concern for the third-quarter earnings results because Netflix had 5 billion in cash reserves at the end of the second quarter.
Nonetheless, the company expects year-over-year subscription growth of 21.6% for the third quarter. And we certainly hope that the company lives up to expectations or else it will be a tell-tale sign that the company’s management is not prepared to take on the streaming war.
Content Cost – A Nightmare
As other streaming services prepare to launch, Netflix will need to produce more original shows to lure subscribers. As a result, Netflix’s content cost will go up. In fact, the company has already spent $6.3 billion in the first six months of this year and is widely expected to spend $15 billion by the end of this year.
Needless to say, Netflix has spent substantially on content in the third quarter, which might hamper its profit margin. For perspective, Netflix spent $8.9 billion and $12 billion on content in 2017 and 2018, respectively.
Expanding content, by the way, is an important aspect. Although Netflix’s competitors will spend heavily on content to gain subscribers, they are not solely dependent on content for revenues. For instance, if Apple doesn’t have a hit show, it still has iPhone. But if Netflix flops, it has nothing to fall back on.
It Will Only Get Harder
No matter which way Netflix’s stock moves following the earnings release, slump in subscriber addition and rise in streaming competition are likely to show on its third-quarter results.
In fact, Netflix has an Earnings ESP of -2.86%. This is Zacks’ proprietary methodology for determining stocks that have the best chance to surprise with their next earnings announcement. It provides the percentage difference between the Most Accurate Estimate and the Zacks Consensus Estimate.
Over the past two months, investors have seen five earnings estimates move lower for the Zacks Rank #3 (Hold) company. None of the estimates were revised higher, at least when looking at the current-year time frame. Meanwhile, the Zacks Consensus Estimate for earnings has moved down over the past 60 days, as estimates fell 1.5%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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