Ask the Rational Investor: Netflix is now a quality stock!
The telecom industry has been undergoing ‘cord cutting’ a dramatic change to the industry that has accelerated the last several years due to faster internet speeds (impacting downloading and uploading), increased adoption of smart devices connected to the internet (e.g. phones, ipads, tvs) and changes in attitudes toward viewing commercials.
Netflix represents a value option for consumers with an international breadth of content that is continuously updated. A disrupter to the industry, Netflix initially offered an alternative to brick-and-mortar video rental companies and successfully transitioned their business to a scaled internet streaming service leader.
Netflix’s business model has recently reached an inflection point in maturity with dramatic changes expected to occur to their profitability over the next 3-5 years. As management recalibrates their business model towards profitability, we expect a new investor group to be interested in the stock as the company will offer high single-digit to low double-digit sales growth and low 20% earnings growth.
Netflix, a dominant streaming service has seen sales growth decline from the high 30% during 2013-2018 to the mid-to-low 20’s from 2020-2021 and decline further in 2022-23. Going forward sales growth is likely to be 7-10% for the next 3-5 years. The slowdown in growth is due to business maturity and increased competition from other communication behemoths. As an example, in 2013 there were approximately 30MM paying subscribers at $7.95 per month and today there are more than 256MM subscribers paying $11.58 per month.
As the topline growth analog has slowed management has focused on profitability and free cash flow (FCF), which has been showing signs of inflecting for the last few years. Between 2011-2021 FCF has generally been negative. During these periods NFLX’s spend on content was growing in-line with sales but from a relatively low level of about $1.7BN in 2012 to $17BN in 2021.
While sales growth has slowed the predictable nature of free cash flow, and profits have increased as the company has reached maturity. Other factors favorably impacting profitability have been streamer consolidation and equity markets acknowledging the industries long-term return on content issues.
Going forward a scaled business model should continue to represent value for customers, while less competition should lower content prices thus improving the fundamentals of streaming more broadly, but much more so for large players such as Netflix.
We believe Netflix is in a transitionary period from growth investors to the new owner as the company currently trades near low valuations on almost every valuation metric, but especially free cash flow.
Investors should always consider their own objectives and risk tolerance prior to investing in any company.
Sources: Factset, Company Reports
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio.