Netflix Outlook: $245 By 2013

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 |  About: Netflix, Inc. (NFLX)
by: Dividend Kings

Netflix, Inc. (NASDAQ:NFLX) is an industry leader in by-mail DVD rental and unlimited online streaming of movies and television shows. They are constantly growing with advances in technology and offering these services through new video game consoles, smart phones, tablets, and are working on adding additional host devices as they are produced.

NFLX began in the US, but within the last year has expanded to Canada and Latin America, and during Q1 of 2012 will expand to the U.K. and Ireland. Domestically Netflix competes with companies like HBO, Blockbuster (BBI), Hulu Plus, and Coinstar (CSTR) Red Box. Internationally, it faces some competition in the U.K., but doesn’t feel that it will bar entry into that market.

The company notes that it doesn’t feel Netflix will ever be the only streaming media service in a home, because of the niche that it fills. It feels that subscribers may use Hulu to get recent TV and Red Box to get new movies faster, while still using Netflix for classic TV and movies. I think this is a good beginning strategy, but at some point they will need to decide to get into some of these other offerings to win customers from other current competition before competitors start to creep into their business.

The share price has been destroyed lately because of issues discussed here, but I feel that it was merely a correction and that shares are fairly valued and even missing any growth related to the U.K. expansion. The 52-week high was $304 as recently as July, and the stock currently trades around $70. I think the floor will fall a little farther, and suggest the $65 mark as a buying point. This will all be dependent on the end-of-year results released in January, and then even more so the first quarter after the U.K. launch.

In the end-of-year results, we’re hoping to see the hemorrhaging of subscribers from the blown price increase and attempt to sever the DVD business has stopped. The first quarter after the U.K. launch we’ll be looking to see how well it's being received and its projections for growth, revenues, profitability -- specifically in the U.K. -- and how that will help the overall bottom line.

Recently Netflix has come under fire for their decision to increase prices while trying to separate its DVD-by-mail from and the core business, streaming. Company executives have quickly realized their errors and have taken corrective efforts. The fallout has been noticeable, however: There have been a large number of cancellations, a decline in new subscriptions, and CEO Reed Hastings CEO was voted the worst tech CEO of 2011i n a TheStreet.com poll.

In the most recent letter to shareholders, though, Netflix addressed this error and said the negative impacts are coming to an end. It publicly announced and clarified the reasons for the increase in subscription price, and acknowledged it should have done this prior and made incremental increases it over a longer period of time. NFLX also notes that the large wave of cancellations is beginning to dwindle, and it hopes to report that it is over when it announces end-of-year results in January.

I hope this serves as a learning experience so in the future the company will poll its customers for input on what they want going forward. I do think it was the right move, because streaming video is the way of the future; unfortunately too much change too fast alienates people.

Netflix will also be releasing its first exclusive “TV” series available only through its website. Being the first to secure this could lock it in for lots of new subscribers if it gets it right. Also, this again shows the company pushing streaming video as the future medium.

Another concern that has recently arisen is the U.S. Postal Service announcing closing facilities and possibly increasing delivery times. The USPS said for large customers they could still get deliveries in before a “critical time” and they could still be delivered on today’s delivery timetables; overall of no concern to Netflix. If anything, this would force people from mail to streaming, which is what Netflix is hoping for anyway.

Financially, Netflix is a stable company. It recently took a $200 million loan, and I believe that will be used to support its expansion into the U.K. Their P/E ratio is 15.8, which is less than its peers at 21.5, but slightly above their industry average of 14.4. The debt to equity ratio is 0.6, vs. peers at 0.3 and an industry average of 2.4. Return on equity is 82%, which is 4 times its peers and industry.

I think Netflix is undervalued based on the growth coming from the U.K. expansion. It is covering its debts well already, even before receiving any revenues from the U.K. I think the pullback to $70 was good, because the stock was very overpriced when it was up near $300/share. For FY 2012 NFLX is already expected to post a loss tied to the recent and planned expansions. I think this will cause a slight continued drop in share price. But if it even reports less of a loss than expected, it will signal that U.K. revenues are coming in faster than planned, and that the loss of U.S. subscribers has stopped, which would both be great indicators. This will restore faith and confidence in the stock and send it back on an upward path.

2012 would also be the first loss posted in the last 5 years. It has posted increasing revenues and earnings per share each of the last five years. I feel NFLX's willingness to possibly post a loss speaks to its desire to take on minimal amounts of debt and grow off of operating cash flow. Analysts have a low target of $45 and a high target of $245. I think a more realistic target for end of FY 2012 would be $100 with a low of only $60. This is based on the drop bringing its current price back to a more accurate valuation of the company based on previously mentioned ratios.

Any new buying will be more conservative, and will be tied to actual reports and more conservative growth estimates and less to speculative reports. I think by end of 2013 we could see the high analyst target of $245, depending on what other growth the company takes on and how it continues to reinforce its moat.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.