Goldman Sachs (GS) analyst Eric Sheridan cut Netflix (NFLX) stock from a neutral rating to a sell this week due to a gloomy outlook for the streaming space.
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Sheridan released a research note stating the following: “we have concerns around the impact of a consumer recession as well as heightened levels of competition on demand trends (both in the form of gross adds and churn), margin expansion, & levels of content spend.”
Netflix’s Headwinds
As Sheridan mentioned, we’re in a contractionary environment. Subscriptions hold excess sensitivity to economic cycles due to their cyclical nature. With household obligations rising and real wages stagnating, consumers will likely spend less of their disposable income on add-ons such as subscriptions.
Netflix’s first-quarter earnings results conveyed the subscription bear trend that’s unravelling. During its first quarter, Netflix’s net subscription base fell by approximately 200,000 users, recording its first drop in users in a decade.
Netflix tried justifying the drop in subscriptions after the report was released by stating that “revenue growth had slowed considerably… Streaming is winning over linear, as we predicted, and Netflix titles are very popular globally. However, our relatively high household penetration – when including the large number of households sharing accounts – combined with competition, is creating revenue growth headwinds.”
However, as previously mentioned, the erosion of real economic prospects is a concern to cyclical companies such as Netflix. Moreover, the firm is facing significant competition from platforms such as Disney+, Amazon Prime, HBO Max, and an influx of more minor market participants. Increases in market participation are natural as an industry matures, and it remains to be seen whether Netflix can buckle the trend to sustain its market position.
Website Clicks
TipRanks’ website visit tracker indicates that Netflix’s website traffic has declined considerably since the turn of the year. Whether that be due to post-pandemic re-openings, competition, or economic tightening is debatable. Nevertheless, it’s illustrated that Netflix’s stock price holds a strong correlation with its website traffic.
The company’s latest quarter’s financial results are still en route. However, TipRanks’ artificial intelligence network forecasts visits to be lower again, which could lead to a subsequent stock price drawdown.
Valuation & Pricing
Netflix stock is overvalued. Relative to the firm’s sales, the stock is trading at a 2.m81x premium and its trading at a 159x premium relative to cash flow. Although many growth stocks’ overvalued multiples can be justified, that’s not the case for Netflix, as its growth metrics are waning.
From a growth point of view, Netflix’s intrinsic value is fading. For example, its free cash flow growth has contracted by 81.72% in the past year. In addition, Netflix’s working capital has shrunk by 83%, implying that it might suffer from liquidity issues in the near future.
Lastly, Netflix stock is overpriced, with its Sharpe Ratio stacking up poorly at -0.13. The Sharpe Ratio measures a stock’s excess return with respect to the broader market’s volatility, and a ratio of more than 1.00 implies that a stock’s risk is poorly aligned.
Wall Street’s Take
Turning to Wall Street, Netflix earns a Hold consensus rating based on nine Buys, 27 Holds, and four Sell ratings assigned in the past three months. The average NFLX stock price target of $293.17 implies 60.25% upside potential.
Concluding Thoughts
Netflix is in tremendous trouble, which is why it’s been downgraded by Goldman Sachs. The company’s subscriptions are deteriorating due to industry congestion and economic contraction. In addition, Netflix stock is overvalued and overpriced due to poor quantitative alignment.
