Netflix stock is down nearly 10% after releasing their Q1 2021 earnings. 10%... That's a HUGE number! So, let's do a deep dive on why this happened, and whether there's a potential buying opportunity.
Here's a link to the Netflix Q1 Shareholder Letter (for your reference).
WHY THE CRASH?
- Earnings came in at $3.75 per share, which is a 26.3% beat to estimate (GOOD NEWS)
- Operating margin hit 27.2% – their highest ever! (GOOD NEWS)
- THE "BAD" NEWS: Global subscriber growth grew just 13.6% YoY versus Netflix's guidance of 14.7%. That's a one percent miss, which isn't too bad in my opinion, but I reality just hit for investors who didn't want to believe the slowdown was coming.
Netflix had given a fair heads up about the slowed growth post-pandemic, because a lot of the growth was pulled forward due to people being at home during the pandemic. In fact, Netflix was expecting the slower growth in subscribers in 2020 – which obviously didn't happen because of the pandemic. A pleasant surprise, I guess? Well now comping the 2020 growth is inevitably going to be impossible... and that's going to be the case for not just Netflix, but all the other "pandemic stocks".
Pandemic stocks: Stocks of companies who benefited from the pandemic (i.e. Zoom)
But, that's not the end of the story... there's a lot of competition coming in for the digital streaming market share. And, I believe that's spooking investors more than anything.
Although the chart above seems impressive, Netflix's market share has been declining. While it's still the dominating player, with 10 years of competitive advantage, two years ago Netflix accounted for 64.6% of demand.
On the surface, it appears that Netflix is losing this race, but we need to factor in the HUGE head start they have... and the pace at which the streaming industry is growing, from which they are still net gaining subscribers. The video streaming market is expected to grow 12-21% CAGR – which Netflix appears to be staying on pace with.
“Are we sure it’s not competition? Because obviously there’s a lot of new competition,” Reed Hastings, the company’s co-chief executive along with Ted Sarandos, said on the earnings call after the report. “It’s intensely competitive, but it always has been. We’ve been competing with Amazon Prime for 13 years, with Hulu for 14 years.” He added: “So there’s no real change that we can detect in the competitive environment.”
BUY THE DIP?
In order to understand if we should buy the dip, we simply need to ask whether Cathy Wood bought the dip... If yes, then buy. If not, then pass. I'm joking of course. But, she did buy almost 60,000 shares. Keep in mind, she dumped 28,000 shares of Netflix in March – smart move.
On a more serious note, let's start by looking at fair value of Netflix. I've played around with several discounted cash flow methods (I won't bore you with the details) and cross-referenced my fair value with other analysis. I do believe the fair value of Netflix is ~$500. That means, at today's prices, we're paying pretty close to that... which you complain about.
I played with several assumptions, which you can see below, and I just can't see a scenario where Netflix doesn't reach $600 per share. Now, whether it be this year or next... I don't know. But, we will get there.
I will link the spreadsheet to premium members (BETA) only. Only because it's not polished, but it would be worthwhile playing with your own assumptions. I assumed modest subscriber growth, which declines significantly in later years (what investors are fearing). The most conservative assumption I made here, is a significant compression in Netflix's P/E ratio. They're currently trading at 60X P/E, whereas I do believe this will eventually compress to 35-45X in the next few years. Netflix is becoming a more stable, profitable company. Isn't this what investors wanted?
I also assumed Netflix would have 300 million subscribers by 2023, whereas Ark Invest forecasted 400 million by the same time. I always stay as conservative as possible.
Of course, there is risk... which, as I mentioned, is likely in the competition. Netflix might not have the luxury of increasing prices as much as it may have in the past. And, it will need to be super competitive with its releases.
This is a list of the most in-demand shows during the first quarter. Netflix accounts for 7 of the 10, but Disney+ and Amazon have entries as well. Note that Disney+ has the two biggest.
Production, or content creation, has been a huge problem for the industry as a whole, which management has pointed out. But, Netflix is doing a great job at "globalizing" content. They're essentially creating hits in local languages, which are carrying out to be hits at home as well... think Money Heist (from Spain) or Who Killed Sara? (from Mexico). I'm only naming the two I watched... which were both great.
In conclusion, I am slightly bullish on Netflix up until $600 per share. I would buy some at $500 (where it is now) and buy more if it dips between $480-500 (I don't see it going below that imho). It really depends on whether Netflix can innovate from here to solidify it's position at the top. I wouldn't put it past them to do that... since they have proven to do so in the past. After all, they were the industry pioneers in digital streaming after mailing DVDs to people at home. One of their founders, Reed Hastings, is still active... and I would never bet against a founder, because they're always something special a founder shares with his company.
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