NFLX - Netflix Blows The Lights Out: Revenue Growth Accelerates Cash Flow Margins Keep Rising Deleverage Continues

2023-10-18 17:15:36 ET

Summary

• Netflix has become a fundamentally strong business, with positive cash flow and improving cash flow margins. Revenue growth is accelerating, and cash flow margins are improving at the same time.
• The company's leverage has decreased significantly, indicating a solid, fundamentally improving business.
• Management expects further revenue growth and increased operating margins, suggesting scale and better revenue yield from content assets.

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Don't Look Now But Netflix Became A Really Good Business Already

For a very long time, if you were at all interested in fundamentals, meaning cash flow, it was hard to get excited about Netflix ( NFLX ). Yes it had big revenue growth and was adding vast numbers of subscribers. And yes it was posting positive EPS for some time. But once you actually looked at reality - the actual money actually produced by the business after they paid for stuff - it got a lot less convincing.

That started to change in early 2020 as the company began to clock up cashflow-positive quarters. And then all you had to worry about, if you were fundamentally inclined, was the leverage - which peaked at 8.0x TTM unlevered pretax FCF in the December 2021 quarter. The stock already was in freefall at that point, of course.

The story of Netflix stock from the May 2022 bottom to the present day is that fundamentals and the stock price have improved side by side. Yes, growth is down - 8% this quarter and just 4% on a TTM basis, a far cry from the 20%-30% rates it chalked up in 2019-2021 - but cash flow margins are up, way up - 21% UFCF margins on a TTM basis this quarter, up from just 6% two years back. And leverage is down from that 8.0x TTM UFCF peak in Dec-21 to 0.9 xTTM UFCF this quarter. These are all the hallmarks of a solid, fundamentally improving business - and if it's maturing since its early days of untrammelled growth, so be it, you just have to bear that in mind when it comes to owning or not owning the stock.

Fundamental Analysis

Here's the fundamentals up to and including this quarter.

Management guided for a further acceleration in revenue growth in Q4 this year - and signaled that their expected operating margins for the FY12/23 year would come in nearer 20% not the 18% originally guided. That's quite a statement - accelerating revenue growth and increased margins. It suggests they see some scale to their content assets - spend less, grow more, means that the capex in the ground - the programming costs - is starting to obtain a better revenue yield. This is very good news for the stock, and it's a positive commentary on management's ability to buy the right content and to market and price it well.

Valuation Multiples

Technical Analysis

Here's the longer-term stock chart as we see it.

The huge drop in 2022 saw NFLX stock arrest at the 78.6% retrace of the whole move up since the IPO lows. That's remarkable given the IPO low was in 2012 and the peak was in late 2021! So, nine years' stock price growth, 80% surrendered in just seven months, from October 2021 to May 2022.

That kind of drop is usually indicative of a larger-degree Wave 2, which is often a sharp drop followed by a V-shaped recovery. Meta Platforms ( META ) did something similar last year, by the way. Both stocks have recovered in a similar fashion.

In the longer term we believe the stock can recapture its all-time highs - we say this in the context of our house view that the present bull market will continue for some time . But first the stock has to chew through the high volume nodes (gray bars on the right hand side of the chart) between here and around $445/share. Within those nodes lurk many regretful holders who may look to exit at cost or thereabouts. This inventory of stock held for sale is what acts as resistance as a stock plows upward through this much historic volume. The air becomes thinner after $450, and if NFLX stock gets there, we believe the climb will become easier, since there are very few holders up there above that price.

We rate the stock at Hold, since it is well off its lows. We own the name in staff personal accounts and are simply holding, not adding or selling.

Cestrian Capital Research, Inc - 18 October 2023.

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