On Tuesday evening, the acknowledged leader in streamed entertainment, Netflix (NFLX) released the firm's first quarter financial results.
For the three month period ended March 31st, Netflix posted GAAP EPS of $2.88 on revenue of $8.162B. While the bottom line result beat Wall Street by two cents and the firm's own guidance by six, the bottom line number fell just short of both consensus and the firm's guidance. Revenue did grow 3.7% year over year.
Cost of revenues that includes marketing, technological development and administrative expenses increased 12.1% to $4.804B. This took operating income down 13.1% to $1.714B. In terms of operating margin, the quarterly result of 21% was down significantly from Q1 2022's 25.1%. After accounting for interest and taxes, net income decreased by a somewhat alarming 18.3% to $1.305B.
This gets us to the EPS print that compares rather poorly against the year ago comparison of $3.53. Netflix added 1.75M net new subscribers during the period, which was good for annual growth of 4.9%, but well short of the 2.25M or so that Wall Street was looking for.
Guidance
For the current quarter, the firm sees revenue of $8.2B, which would be up 3% year over year or up 6% on an FX neutral basis. The firm is pleased with the recent launches of paid sharing in nations where it has been implemented. "Paid sharing" for those who have not heard of it, is the firm's way of cracking down on unpaid usage. Basically, this program requires an extra fee be paid in order to add profiles for those living outside of the household of the account owner.
The broad roll-out of this program is set to launch in Q2, with a revenue benefit visible by Q3. In Canada, the firm states that the initial reaction was one of cancellation, that was then followed by "increased acquisition and revenue" as consumers adjusted. Paid membership in Canada is now larger than it was prior to this launch with revenue accelerating.
The firm sees Q2 operating income of $1.6B, which would be close to flat from last year on an operating margin of 19%. That would be down from 20% a year ago, largely due to US dollar strength versus other currencies over the past year.
Netflix also sees constant currency revenue growth accelerating over the second half of 2023 as not only the positive impacts of the paid sharing program are felt, but also as the advertising business grows. Operating profit and operating margin are expected to grow for the full year. Netflix is targeting a full year operating margin of 18% to 20% based on currency exchange rates on January 1, 2023. Netflix is targeting free cash flow of $3.5B for the full year, which would be up from the firm's previously given target of $3B.
Fundamentals
This is very interesting, and probably (my opinion) the reason why the shares rebounded as they did last night. For the period, Netflix drove operating cash flow of $2.179B (+136%). Out of this came just $62M worth of CapEx (-49%), leaving the firm with free cash flow of $2.117B (+164%). The firm repurchased $400M worth of common stock during the quarter and expects to accelerate those purchases over the balance of the year. These numbers are just stunning, so of course I went through the statement of cash flows item by item.
It looks like Netflix shaved cash spent on content addition by $1.126B from the year ago comp, which in turn knocked accounts payable significantly lower. The firm also beefed up its amortization of content assets by $293M, while cutting "other" liabilities by $99M. Basically, Netflix seriously cut costs, and the largest cut made, by far, was to content addition.
Turning to the balance sheet, Netflix ended the quarter with a cash position of $7.828B and current assets of $10.483B. Current liabilities add up to $8.316B (including $399M in short-term debt). This brings the firm's current ratio to 1.26, which is healthy. Total assets amount to $49.49B. The firm does not claim any value for goodwill or intangible assets of any kind. Total liabilities less equity comes to $27.662B. This includes $14.038B in long term debt.
I would rather not see debt at twice cash, but I am old fashioned in that thinking and this balance sheet is not a weakness. This is probably why Moody's recently upgraded the firm's credit rating to investment grade status.
Wall Street
Since these earnings were released last night, I have found 15 sell-side analysts who have opined on NFLX in response and are also rated at a minimum of four stars out of five by TipRanks. After allowing for changes, we have seven "buy" or buy-equivalent ratings, seven "hold" or hold-equivalent ratings and one outright "sell" rating. Two of the "holds" did not set target prices, so we are working with 13 targets.
The average target price for NFLX across these 13 analysts is $343.46 with a high of $410 (Bryan Kraft of Deutsche Bank) and a low of $230 (Eric Sheridan of Goldman Sachs). Once omitting these two as potential outliers, the average across the other eleven rises to $359.55.
My Thoughts
This is a mixed report. Performance is "so-so", while free cash flow generation was outstanding. That, however, came at a cost. That cost was less product. We all know folks who complain about what's available for streaming. There is only one person left in my household that still watches Netflix. They're just lucky it's my better half, otherwise, they'd be gone.
I have my doubts concerning the success of the firm's paid sharing program across the US as the US enters into recession. They may see the initial reaction that they saw up north. I don't know how well the consumer adjusts when one sees data that shows 21% of BNPL (Buy now, Pay later) purchases are made on groceries.
Let's just say that so and so has moved out of the house and is struggling, buying groceries over installments but so and so still watches Netflix on his or her parents' account for free. You think so and so is going to pay for Netflix when he or she is taking out a loan to buy food?
Readers can see that NFLX has enjoyed a nearly year-long run from the May 2022 lows. The Pitchfork broke however in March of 2023.
Readers will now see that coming out of that Pitchfork, NFLX had developed a classic cup with handle video with a $350 pivot. The stock was set up for a positive response last night/this morning. Instead, the stock has extended the handle and in the process, gave up its 21 day EMA (exponential moving average) and 50 day SMA (simple moving average). This very well may have broken the cup with handle. We'll know for sure if NFLX fails to quickly take back those moving averages.
If the averages are retaken, then the $350 pivot is still in play. Now, for an ugly warning. Should resistance show up at the 50 day line, then the 200 day SMA (currently $281) becomes a target to the downside.
Keep in mind that the stock is expensive at 29 times forward looking earnings. This is no growth stock. Not even close. It's not like the firm pays a nice dividend like other slow-growth types in order to keep folks invested. That said, they are buying back stock. I'd rather have the dividend to be honest.
The July $280 puts are paying about $10.60 this morning. Tempting sale. You could buy the July $270 puts for protection. That would cost a rough $8. Not sure it's worth it. You could sell the $280's with no protection. I wouldn't.
