Netflix Earnings Preview

| About: Netflix, Inc. (NFLX)

Summary

Historically, Q4 is a strong quarter for the company and the stock responds well to the Q4 ER.

Street estimates, however, are aggressive and the company will need a significantly above-trend quarter to top expectations.

High-profile licensed content additions throughout the quarter likely boosted sub growth.

International growth likely impressed during the quarter, and that has bullish long-term growth implications.

Netflix (NASDAQ:NFLX) is set to report Q4 earnings this Wednesday, 1/18. Shares have rallied significantly this year, with much of that move coming after a strong Q3 ER. While we like the company's long-term growth story and the stock's long-term growth potential, we admit that the valuation here is subject to compression if sub growth disappoints. We don't think that will happen (we think the company will report numbers ahead of expectations), but we do not believe the reward-risk asymmetry into earnings is all that favorable. Our strategy is to remain long into earnings, and buy more on any post-ER dip.

(Source: MarketWatch)

Our observations heading into the quarter are as follows.

  • Historically, Q4 is a strong quarter for the company and the stock rises sharply in response to the Q4 ER. In each of the past 3 years, Netflix has reported strong Q4 earnings and shares have rallied significantly in after-hours trade. In early calendar 2014, shares soared after the Q4 ER impressed with strong domestic sub growth. In early calendar 2015, shares also soared after the Q4 ER impressed with strong domestic and international sub growth. The same thing happened last year (before a sharp reversal in the following days). The stock has good momentum here after a strong Q3 report, so the set-up looks good for Netflix to once again surprise on the sub growth line.
  • Street estimates, however, are aggressive and the company will need a significantly above-trend quarter to top expectations. In both 2014 and 2015, Q4 revenues grew roughly 5% sequentially from Q3. The consensus estimate this year calls for 8% sequential growth. On a YoY basis, the Street is looking for 35% growth, which is significantly above-trend over the past several quarters. We think achieving this growth is possible given international tailwinds, but its also a high bar and investors should be aware of this.
  • The original content line-up in the quarter, while strong, was not nearly as good as the original content line-up in the late summer quarter. Q3's big beat was driven largely by a strong original content line-up in the late summer which was headlined by Stranger Things, Narcos, Marvel's Luke Cage, and The Get Down. The original content line-up this past quarter, which featured names like Black Mirror and The Crown, was good, but pales in comparison to the strong summer line-up. As a sample of scale, Stranger Things has 250,000 votes on IMDb and Narcos has 160,000 votes. While Netflix's more recent originals have high scores, they don't even come close to that number of votes (Black Mirror has 100,000 votes while The Crown only has 20,000 votes). Moreover, Google (NASDAQ:GOOG) Trends shows that Narcos and Stranger Things were much more searched during late summer than Black Mirror and The Crown were over the past 3 months. Overall, while we remain bullish long-term on the platform's original content push, it does not look like this quarter's domestic original content releases had the same impact as last quarter's domestic original content releases.
  • High-profile licensed content additions throughout the quarter likely boosted sub growth. As we pointed out in our last article, Netflix made some high-profile licensed content additions to their platform over the past 3 months, including Disney (NYSE:DIS) favorites like Captain America: Civil War and Jungle Book. Google Trends shows that consumers were fairly excited about the release of these films on Netflix, so we see these high-profile licensed content additions as potential catalysts for accelerated domestic and international sub growth during the quarter.
  • International growth likely impressed during the quarter, and that has bullish long-term growth implications. Looking through Seeking Alpha's Netflix News Feed, it looks like multiple Wall Street analysts have taken bullish stances on the stock over the past 2 months. It seems a consensus read is that the international sub growth number will be quite good. Our analysis seems to corroborate that thesis. Looking at Netflix's search interest both in the US and worldwide over the past 5 years, it becomes increasingly clear that international is the big growth driver of the company. This trend appears to have accelerated recently. Perhaps a big reason why is Netflix's announcement of a download option for offline viewing at the end of November, something vital to certain global markets with limited Internet access. A beat here has significant long-term growth implications for the company, as this will bring Netflix closer to the 140 million international subs we expect for the platform by 2025.

Overall, we think the quarter was quite good, and that Netflix will post domestic and international sub growth numbers ahead of expectations. We think the domestic beat was helped largely by the addition of some high-profile 2016 Disney movies in November and December, while the international beat was driven by download functionality build-out and quality international originals. That said, we believe the valuation is subject to compression on any slight sub growth miss, and that the reward-risk profile isn't terribly favorable into earnings. As stated earlier, our strategy is to remain long into earnings, and buy more on any post-ER dip.

Disclosure: I am/we are long NFLX, DIS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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