We recently reiterated our Neutral recommendation on Netflix Inc. (NFLX - Analyst Report) following the company’s better-than-expected second quarter results.
In its second quarter, Netflix reported earnings of 11 cents that bettered the Zacks Consensus Estimate of 4 cents. The company reported a top-line expansion of 12.8% on a year-over-year basis to $889.2 million, which was just ahead of the Zacks Consensus Estimate of $889.0 million.
Netflix’s huge subscriber base is the primary factor that has helped the company to generate incremental revenues. Netflix ended the second quarter with 30.1 million unique subscribers, adding 4.56 million unique subscribers over the last 12 months. Moreover, this increase in subscriber base can be attributed to the dynamic programs and shows that are being streamed by Netflix. Netflix has been entering into licensing agreements with several big Hollywood production houses to bolster its streaming content library.
Moreover, Netflix has been expanding its international operations beyond Canada, Latin America and the Caribbean. The company has already started its streaming services in the U.K. and Ireland. Additionally, Netflix plans to expand its streaming services to the four Nordic countries of Norway, Denmark, Sweden and Finland by the end of 2012.
However, the international expansions are escalating costs in the form of technology investments (51.1% increase year over year in the first six months of fiscal 2012) and marketing expenses (27.5% increase year over year in the first six months of fiscal 2012). Moreover, operating expense as a percentage of revenue expanded 310 basis points in the first half of fiscal 2012.
Another major near-term challenge for the company is cost escalation in the form of license and renewal fees. Additionally, the company’s DVD business is continuously losing subscribers. The company’s international operation has still not managed to generate profit. In the second quarter, international streaming operations reported a loss of $89 million, which was significantly higher than the $9 million loss reported in the previous-year quarter. However, the company can get some relief from the fact that total international streaming subscriptions has increased on a year-over-year basis as well as sequentially.
Moreover, the company faces competition from bellwethers, such as Amazon.com Inc. (AMZN - Analyst Report) and Verizon Communications Inc. (VZ - Analyst Report) , which will remain an overhang on the stock going forward.
Currently, Netflix has a Zacks #3 Rank, which implies a Hold rating in the short term.