Netflix share – Tenbagger for your depot?

Video streaming has turned the Netflix share into a “tenbagger” within a few years. In the fall of 2013, the Netflix share cost 50 dollars. Today it’s worth $ 540. That corresponds to an annual return of 40 percent!

However, the success of Netflix has attracted powerful competitors such as Walt Disney or Amazon, who claim more than just a few crumbs from the cake. Netflix is ​​still the top dog in the streaming industry with the most subscribers. In this stock analysis you can find out whether there is further potential in the Netflix share despite the rapid rise in prices and increasing competition.

Netflix share
Market capitalization€ 208.5 billion
Dividend yield
Stability dividend
Stability gain0.71 of max. 1.0

The business model: This is how Netflix makes millions

Netflix is ​​the ultimate streaming provider for films and series. On the platform of the same name, customers can take out a paid subscription to get unlimited access to all content. Different subscription models are offered, which differ in price and performance. The cheapest offer costs e.g. in Germany 7.99 euros per month and does not allow parallel use on different devices. The streaming quality is also limited. On the other hand, the premium tariff strikes at 15.99 euros, which can be streamed in 4K resolution on up to 4 devices at the same time. In between there is a tariff for 11.99 euros that allows simultaneous streaming on 2 devices in HD quality. The three-tier subscription model is priced differently depending on the country. For example, the basic tariff in Switzerland costs the equivalent of 11.08 euros (11.90 Swiss francs) instead of 7.99 euros. The streaming offer also differs from country to country. In sum, however, it can be said that the Netflix pricing model is affordable and designed for the masses, which translates into almost 200 million subscribers reflects.

Parallel to the Netflix stock analysis, there is also a video for you on Netflix stock on the stock finder YouTube channel

Income from the streaming business is Netflix’s main source of income. However, many readers are probably unaware that Netflix has a second, if rather modest, source of income. In 1998, Netflix began renting DVDs. The business model should be an alternative to rental in video stores, because the DVDs were sent to the customer by post. Initially, customers had to pay for each DVD individually. It was later switched to a subscription model in which customers paid a fixed amount and could then rent an unlimited number of films. Netflix is ​​still in this line of business today, earning $ 297 million last year (2020 Annual Report, page 20). This corresponds to around 1.5 percent of total sales. However, sales from DVD rental have been declining for years. Although the rental does not add much to total sales, it is a welcome offer for people in rural areas without access to (fast) internet, of which there were 24 million in the USA alone in 2019 has given.

Netflix revenue by segment

Netflix sales by segment (Source: FactSet Workstation)

The corona effect

In contrast to many other companies, Netflix has benefited enormously from the corona pandemic. Especially at the beginning of the pandemic, many people had to spend more time at home, which is why Netflix gained significantly more new subscribers in the spring than in the same period before. In the second quarter of this year, the number of subscribers rose by over 10 million to almost 193 million. In the first quarter of 2020, the increase was even higher at just under 16 million (quarterly report, page 20). For comparison: in 2019 the increase in the first quarter was 9.6 million and in the second quarter only 2.7 million new subscribers.

Increase in subscribers to Netflix in the second quarter of 2020 (Source: Quarterly Report page 20)

Increase in subscribers to Netflix in the second quarter of 2020 (Source: Quarterly Report, page 20)

In the first half of this year, the growth in subscribers was similar to that in 2019 as a whole. The pandemic gave Netflix a new boost. The subscribers you win are extremely important in order to spread the cost of new films and series among as many paying customers as possible. Since these costs are incurred regardless of the number of viewers, a high number of subscribers is crucial for profitability.

Netflix subscribers (data source: Netflix annual reports)

Netflix subscribers (data source: Netflix annual reports)

Together with the second quarterly report, Netflix already has a forecast for the third quarter submitted. Interestingly, “only” 2.5 million new subscribers are expected in the third quarter. Management believes that this year many subscriptions have been brought forward to the first half of the year.

Competition from Disney and Amazon

Although Netflix is ​​the top dog in the streaming business, its outstanding position must be defended against strong opponents. There are now several challengers whose subscriber numbers are also growing very quickly. Netflix is ​​number one with 190 million subscribers, followed by Amazon Prime with 150 million subscribers. Although not all Prime customers have their membership due to the video offer, they still have access and are therefore more likely not to take out any additional Netflix membership. Disney + is another competitor and has 60 million subscribers in a short period of time brought. With the launch, Disney removed its content from the Netflix platform, which means a weakening of the offer for Netflix. Disney also has other streaming platforms, such as Hulu and ESPN +. Overall, Disney has a subscriber number of over 100 million.

The decisive factor for the fierce competition will be whether customers opt for just one provider in bulk, or whether several subscriptions are used in parallel thanks to the affordable prices. The latter would reduce competitive pressure. Since the growth curve of the counterparties has not yet shown any flattening, I suspect that the several providers may also coexist in the future to a certain extent.

Streaming competitors as alternative investments

In addition to Netflix, we recently also analyzed the two major competitors Amazon and Walt Disney. A click on the respective link takes you directly to the stock analysis. Our free stock research is based on full memberships financed in Germany’s most popular share finder.

Amazon share - 8000 percent price gain - Now another buy
Walt Disney Share - The fairytale train has left

That’s how profitable Netflix is

Netflix has increased profits fourteen times from $ 0.43 to $ 5.93 since 2016. Since Netflix actually increased the number of shares outstanding during this period, earnings growth at the company level is even slightly greater. Nevertheless, the cash flow was always negative within the same period.

Netflix profits and cash flows

Development of earnings and cash flow per share of Netflix

The high expenses for the streamed content are responsible for the negative cash flow. The production of your own films and series devours a lot of money. Most of the expenses are incurred while shooting. A finished production then represents an asset that Netflix then amortizes over several years (usually within 4 years). In this case, amortization means a write-down on intangible assets. These amortizations flow into the profit and loss account as expenses and thus reduce profit. The expenditures for new content have increased significantly faster in the last few years than the amortization of old content. Since the content is amortized over several years, the growing expenses burden the cash flow more than the profit. When licensing third-party content, however, the expenses are distributed more evenly over the years.

As mentioned, Netflix’s profit has grown significantly since 2016. This increase can be divided into two separate effects. One effect is the increase in sales in recent years. The second effect is the increase in profitability, measured in terms of the operating margin. In the graph below you can see that sales have increased from USD 8.83 billion to USD 22.63 billion over the past 4 years. This corresponds to a growth of around 150 percent. If sales are x percent higher and profitability remains constant, profit is also x percent higher. Netflix’s profitability has not remained constant, but has also improved over this period. While the operating margin was 4.3 percent in 2016, it has now risen to 16.6 percent. Roughly speaking, 2.5 times sales with 4 times the margin means 10 times the operating profit. The target for the current year is an operating margin of 16 percent. By the end of 2021, Netflix even wants to increase the margin to 19 percent (Shareholder Newsletter page 3).

Netflix revenue and operating margin

Development of sales and operating margin of Netflix

In case you’re wondering why earnings per share have increased 14 times rather than 10 times: The ultimate profit also includes other factors that are not included in the calculation of operating profit.

Films and series on credit

Although Netflix doesn’t pay a dividend, the repayment power has been negative every year since 2014. The reason for this is the already mentioned negative cash flow. Without positive cash flow, Netflix is ​​dependent on fresh capital to finance new projects. Therefore the debt has increased annually. The debt ratio is currently 75 percent, and the interest accruing on it devoured around 25 percent of operating profit in 2019 (quarterly report, page 24).

Debt and cash including Netflix's repayment power

Debt and cash including Netflix’s repayment power

There is no doubt that spending on new content on the streaming platform is necessary in order to acquire new customers and not to lose existing customers to the competition. However, the status quo is not sustainable. Sooner or later, Netflix will need to be able to keep spending within acceptable limits without sacrificing library quality. Positive cash flow is important in order to be independent of the capital markets. Internal financing from own funds is only possible with a positive cash flow. In addition, positive free cash flow is necessary in order to be able to pay off the debt at some point in the future and possibly also be able to pay a dividend.

Another aspect is the influence of content spending on profits. Since the depreciation (amortization) on the new content starts with a delay, a permanent increase in expenses in the following years will affect the profit in the form of higher amortization. It is essential for profitability that Netflix gets the costs of new series and films under control. Fortunately, management is aware of this problem. The aim is to improve the cash flow situation in the near future.

Is the Netflix share cheap?

The valuation of Netflix shares is difficult as the company is still in the growth phase and has a high P / E ratio. In addition, the P / E ratio fluctuates greatly from year to year. Because of these facts, an evaluation based on historical averages is less meaningful than in the case of a company that has existed for a long time, such as Amazon. In addition, the operating cash flow is useless for determining a fair value, since Netflix has consistently achieved negative cash flow in recent years. Netflix also doesn’t pay a dividend, which means that the fair value dividend is also omitted. So what remains are the fair values ​​for profit and adjusted profit. Personally, I find the adjusted profit more suitable as it better represents the delayed effect of the content output. I choose a 3-year evaluation period, starting in 2018, in order to only reflect the latest developments. Nevertheless, we come to an average PER of 105. From this point of view, the Netflix share even seems to be fairly valued based on the fair value of the adjusted earnings.

Netflix in Dynamic Stock Valuation

Netflix in Dynamic Stock Valuation

However, you should be careful with the forecasts for the coming years. Due to the high P / E ratio in the valuation and the optimistic forecasts for the coming years, there is an extremely high fair value in the forecast. Personally, however, I am skeptical whether the Netflix share will keep its high P / E ratio in the long term. Once growth rates slow, investors will likely rate earnings at lower P / E ratios as well.

Since the valuation using the historical values ​​is only of limited informative value, I also carried out a discounted cash flow (DCF) analysis. The future expected cash flows are discounted (discounted) and added up in order to obtain their current value. With a growth rate of 25 percent annually for the next 5 years and an operating margin of 19 percent from 2021, I’m getting a value of $ 590 for the fair value of Netflix stock. The DCF analysis also comes to the conclusion that the Netflix share is fairly valued.

DCF rating from Netflix

DCF rating from Netflix

However, you should be aware that a DCF analysis is also associated with uncertainties. The determined fair value depends very much on the assumptions made in the model. With the help of the following table you can get an idea of ​​how today’s fair value in my DCF analysis depends on the assumptions for growth and the operating margin.

DCF sensitivity analysis for Netflix

DCF sensitivity analysis for Netflix

At this point I would like to point out another aspect. In my opinion, much of Netflix’s value depends not just on growth, but on its ability to keep costs under control over the long term. To do this, Netflix must be able to retain its subscribers without having to spend horrendous sums on new content. The growth in subscribers should be helpful in this case, as the costs for the content are then distributed among more users.

Conclusion: Netflix share – a thrill for your portfolio

With the Netflix share you invest in the number one in the streaming industry. The growth in subscribers was once again fanned by the corona pandemic and dynamic growth continued beyond the corona effect. Plus, unlike many other growth companies, Netflix is ​​already profitable. However, there are also negative aspects. Cash flow has been negative for years due to the high costs of new films and series. The high expenditure is necessary to attract new subscribers and to keep the existing subscribers on the platform. A key task in the coming years will be to keep the costs for this under control. Only if this succeeds will Netflix be able to repay its steadily increasing debts and possibly also pay a dividend at some point. The stock isn’t cheap either. In view of the growth rates, however, the price seems justified. However, you should be aware that the valuation of Netflix shares is associated with high uncertainties. Accordingly, the investment carries an increased risk. I advise conservative investors against buying Netflix shares.

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