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Netflix (NFLX) released its Q3 earnings yesterday which seems to have charged up the bulls - the stock is up over 16% at last check. The price action in Tesla (TSLA), meanwhile – which was the other headline earnings report after the close yesterday - is quite the opposite, with that stock down sharply today after it missed both the topline and bottom-line estimates.
As for Netflix, in my pre-earnings analysis I observed that given the stretched valuations, the probability of the stock staging a post-earnings rally was low. However, Netflix impressed markets with its performance. It reported revenues of $8.54 billion in the quarter, which was in line with estimates, but the adjusted earnings per share of $3.73 was ahead of the $3.49 that analysts were expecting.
Key Takeaways from Netflix’s Q3 Earnings Report
Here are the key takeaways from the report, and thoughts on whether you should buy or sell the stock after the post-earnings rally.
1. The Ad-Supported Tier Strategy Is Working
One of the biggest takeaways from Netflix’s Q3 earnings was that its ad-supported tier, which it introduced last year, is working out quite well. While the company still did not provide the number of subscribers in the plan, priced at $6.99 in the U.S. market, it said that plan membership rose 70% quarter-over-quarter in Q3 – which was preceded by a 100% increase in Q2. It also stressed that on average, 30% of the sign-ups were for the ad-supported tiers in regions where it has launched the plan.
2. Netflix Has Pricing Power, Despite Higher Competition
Putting the rumors to rest, Netflix raised its plan prices. The Basic plan will rise by $2 to $11.99, and the Premium plan will increase by $3 to $22.99. The company hasn’t yet tinkered with the pricing of the Standard plan or Ad-Supported plan. Nonetheless, the price hikes – which come amid a tough macro environment for consumers – show that Netflix is leveraging its pricing power.
3. Growth Is Back on Track Amid Password-Sharing Crackdown
In the first half of 2022, many questioned whether Netflix still deserved a place in the coveted FAANG group after losing subscribers in the first and second quarters of 2022. However, the company’s growth seems to have picked up, as it added 8.76 million net subscribers in Q3. For context, that's the highest since Q2 2020, when the streaming industry’s growth was turbocharged due to the global lockdowns. While Netflix has stopped providing guidance for net subscribers, it said that the net subscriber adds in Q4 would be similar to Q3, “plus or minus a few million.”
Notably, to revive its sagging growth, Netflix has started cracking down on password sharing, and has gradually expanded the strategy to new geographies. The strategy has worked well, and Netflix’s co-CEO Greg Peters said during the Q3 earnings call that the company is “incredibly pleased with how it's been going. And you can see the progress from our membership growth in Q2.” He added that the numbers from the password-sharing crackdown are “embedded in the revenue outlook for Q4.”
4. Margin Expansion and Free Cash Flow Generation
Netflix upped its 2023 operating margin forecast to 20% - which is at the upper end of its previous guidance, and implies an improvement of 200 basis points compared to the previous year. It expects operating margins to rise further to between 22%-23% in 2024.
Also, Netflix hikes its 2023 free cash flow guidance to $6.5 billion. However, the higher cash flow should be viewed with a caveat here, as it also accounts for around $1 billion in lower spending on content due to WGA and SAG-AFTRA strikes.
5. Gaming Is a Big Opportunity for Netflix
Netflix sees gaming as a key long-term driver, and Peters said that the company has an “ambitious plan” for this business segment, which it believes is a $140 billion market, excluding China and Russia. Peters added that Netflix is looking to increase its gaming “engagement by many multiples of where it is today over the next handful of years.”
How Analysts Reacted to Netflix’s Earnings
Analyst Mark Mahaney of Evercore ISI, who was also apprehensive about Netflix heading into the Q3 confessional, termed the company’s Q4 subscriber guidance a “big surprise,” while adding that the price hike was a “gutsy” move.
Alicia Reese of Wedbush believes that the password-sharing crackdown helped Netflix add more subscribers in the quarter. However, Goldman Sachs reiterated its neutral rating and $390 target price on the streaming giant - both of which are below Wall Street's consensus opinion on NFLX.
Should You Buy or Sell Netflix Stock Now?
Netflix indeed delivered an impressive set of numbers in Q3, and even as the Q4 revenue outlook trailed estimates, the company more than made up for it with the subscriber forecast. All things considered, though, I would still be on the sidelines and not buy Netflix stock at these prices, primarily due to rich valuations and continued competitive pressure in the streaming industry.
On the date of publication, Mohit Oberoi did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
