Netflix Earnings Preview: No Free Cash Flow Generation Is A Longer-Term Issue

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About: Netflix, Inc. (NFLX)
by: Brian Gilmartin, CFA
Summary

Streaming competition has heated up with the addition of T's HBO and Disney, not to mention Amazon's continued looming presence.

For valuation-sensitive investors, the lack of cash flow and free cash flow is worrisome.

Revenue revisions have been positive, while EPS revisions have turned negative.

Netflix is ridiculously expensive, like so many growth stocks who are first-mover disruptors.

Netflix is trading at 54x 3-year average EPS, with an expected 3-year avg. EPS growth rate of 53% on 27% revenue growth.

Netflix (NFLX) reports their calendar Q! '19 quarter after the bell on Tuesday night, April 16th, 2019, and consensus Street expectations are looking for $0.57 in earnings per share on $4.5 billion in revenue for an expected y/y decline in earnings of 11% on 22% revenue growth.

The bigger picture story for Netflix as competition has heated up is that they have dramatically ramped up content acquisition (i.e. capex) to maintain share and maintain the "first-mover" advantage for the streaming giant.

The cash flow statement:

Netflix Stmt of Cash-Flow Source: valuation and financial spreadsheet

Rather than reinvent the wheel, readers are being shown the statement of cash flow section of since 2015.

Analysts talk about NFLX's lack of free cash flow (FCF), but the fact is the media giant has not had a positive quarter of cash flow from operations since 2014, and even that was just $16 ml, so the innovative streaming giant has been basically cash flow negative for 5 plus years, and judging by the guidance from Q4'18, calendar 2019 will be FCF negative as well.

This is worrisome.

The latest pressure from AT&T's (NYSE:T) HBO and now Disney (NYSE:DIS) this week, and the potential fear of Apple TV (NASDAQ:AAPL) and streaming and then Amazon (NASDAQ:AMZN), the pressure has ramped up markedly for the sector, although pricing is still minimal and even inexpensive. (You'd have to think all this will put the cable companies out of business, eventually.)

The one bright spot to the numbers for NFLX is that revenue revisions remain positive, and there continues to be not only demand for the product but also pricing that seems to allow for ample room to the upside.

Here is a quick look at NFLX's EPS and revenue revisions for the next 3 years:

Netflix forward EPS estimates as of 4/15/19 Source: I/B/E/S by Refinitiv

Netflix forward revenue est Source: IBES by Refinitiv

Readers can quickly see that forward estimates peaked last June 30 for EPS estimates, but revenue estimates have continued to see minor revisions upward since then.

Looking at the 3-year average, EPS is expected to grow 53% with the stock sporting a roughly 54x multiple, and an expectation of 27% revenue growth.

Summary/conclusion:

Some clients with the appropriate risk profile have a small holding in the stock of NFLX, but the multiple is scary, and the downside is extreme if the numbers miss badly.

That being said, the sentiment coming into this earnings report seems too negative, particularly the stock price reaction after Disney's announcement this week, but Morningstar has NFLX classified as a "narrow moat" business, which makes sense, and an "intrinsic value" on the stock of $135.

The narrow moat is understandable, but there seems to be little credit, given for Netflix's "first-mover" disruption ability and, simply, the brand that it's built already in the space.

Reed Hastings and the Board have made a considerable wager on developing proprietary content for Netflix (rather than buying someone else's production), which is a considerably more capital-intensive strategy.

And, it could backfire.

For momentum stocks, taking out the $419, summer of 2018 high would actually be a plus since - if accompanied by positive revenue revisions - would prove the Netflix model remains intact.

Disclosure: I am/we are long NFLX. 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.