On July 18th, Netflix (NFLX) reported its earnings for the June quarter (Q2). Once again, the company delivered solid results, especially in terms of subscriber growth. This success is largely attributed to growth initiatives like the ad-supported tier and the crackdown on password sharing. With a strong bottom line that’s well ahead of its peers, Netflix appears to be trading at reasonable multiples, which supports my bullish stance on the stock.
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In this article, I’ll highlight the key points from Q2, discuss what investors should watch going forward, and explore how attractive Netflix’s share price is right now.
Netflix’s Q2 Earnings Review
Netflix had another solid quarter, beating bottom-line expectations with EPS of $4.88, compared to the consensus estimate of around $4.74. Revenue was slightly above forecasts, coming in at $9.56 billion versus the $9.53 billion consensus.
While the market reaction to the Q2 results wasn’t over the moon, it’s important to remember that expectations were high. Over the past year, Netflix has consistently exceeded expectations in key areas like operating margins and subscriber growth. In the latest quarter, NFLX’s operating margin reached 27.2%, up from 22.3% the previous year, as you can see below.
Subscriber growth was strong in Q2, with global streaming paid memberships hitting 277.65 million. Netflix added eight million subscribers quarter-over-quarter, which was higher than the five to six million expected by analysts. This suggests that the ad-supported tier and the crackdown on password sharing are making a positive impact, potentially setting the stage for further growth.
Netflix has increased its revenue growth forecast for 2024 to 17%, up from the earlier prediction of 16%. The company has also adjusted its operating margin forecast to 26% for 2024, up from the previous estimate of 25%. Additionally, Netflix reported $6.6 billion in free cash flow for the first half of the year, which was above its $6 billion annual guidance. This could mean that Netflix is being overly conservative with its cash flow estimates or that we might see a slight cash flow dip in the second half of the year.
Despite these positive updates, the market’s more cautious reaction is likely due to uncertainties about long-term trends. Questions remain about how sustainable the crackdown on password sharing will be and whether subscriber growth can maintain a strong growth trajectory.
The Next Chapters in Netflix’s Growth Story
The nearly 300% rise in Netflix’s stock value since it fell below $170 per share in mid-2022 indicates that the market is once again viewing Netflix as a growth stock. A few years ago, Netflix’s investment thesis was clouded by uncertainty about its ability to maintain subscriber growth, especially after it failed to grow its subscriber base for the first time in its history.
However, this recent surge in Netflix shares suggests that other factors are now influencing the growth story. In my view, operating margins are a key factor. Even though Netflix reported a 27% operating margin in Q2, down slightly from 28% in Q1, the company still managed to surpass its guidance.
What stands out is how Netflix’s margins compare to the rest of the streaming industry. For instance, Disney’s (DIS) Entertainment and Sports segments reported a combined operating margin of just 11% in its Fiscal Q2. This highlights Netflix’s significant lead in industry profitability.
Looking at Netflix’s financials, it’s clear that the company has managed to grow revenues faster than expenses since 2022. In 2023, revenues grew by 6.7%, while expenses increased by only 3%. With Netflix projecting 17% revenue growth and operating margins of 26% for 2024, it looks like this trend could continue.
Another major driver for Netflix’s growth story is its ad business. The company’s ambitious goal of reaching 40 million ad-supported subscribers in Q3 last year was only achieved in May of this year. While this segment is crucial for subscriber metrics, it still needs to prove itself.
Netflix must improve its CPMs (cost per thousand impressions), increase ad load, and tailor ad experiences for better results. Recently, Netflix announced that its $11.99 per month ad-free plan will be phased out for new subscribers, leaving the $6.99-a-month ad-supported plan and two other more expensive ad-free plans (priced at $15.49 and $22.99 per month).
Regarding the crackdown on password sharing, Netflix’s management mentioned that there were 100 million households sharing passwords over the past year, and the company has added about 37 million more since Q2 2023. This suggests there’s still significant potential to convert non-paying users into subscribers and definitely adds to the growth story.
What About Its Valuation?
Netflix is currently trading at a forward P/E ratio of 33x, which is significantly lower than its half-decade average of 49x. While Netflix may not be considered a bargain stock, it’s certainly not as pricey as it was in the recent past.
With strong growth from its ad initiatives and effective expense management maintaining attractive operating margins, Netflix’s bottom-line growth projections are promising. EPS is expected to grow by 59% in 2024 and potentially 19% in 2025. This suggests that by 2025, Netflix could be trading at a forward P/E ratio of 27.8x, which seems relatively derisked.
Is NFLX a Buy, According to Analysts?
Although not overwhelmingly bullish, the Wall Street consensus for Netflix stock is generally positive. Out of 36 analysts covering the stock, 12 have a Hold recommendation, and one has a Sell recommendation, while the rest are on the bullish side, resulting in a Moderate Buy consensus rating. The average NFLX stock price target of $704.81 suggests 9.7% upside potential.
The Takeaway
Netflix’s Q2 earnings weren’t spectacular, but they were solid and consistent, with notable improvements in subscriber growth and operating income exceeding guidance. While there are some long-term concerns about sustaining growth, initiatives like ads and the crackdown on password sharing are proving to be effective.
With continued content diversification and expense control, Netflix is maintaining high-quality margins. This strategic focus is likely to help Netflix maintain its top position in the streaming industry and position the company well to capitalize on growth opportunities.
