Great First Act for Netflix

Motley Fool Stock Advisor recommendation Netflix (Nasdaq: NFLX  ) announced earnings after the bell on Monday. The DVD-by-mail rental outfit did well in terms of monetary growth, but with a company like this, a lot of investors are just as focused on subscriber growth. Did Netflix make the cut?

For the first quarter, the company grew its top line by a nice 47%, to $224.1 million. Operating income came in at $4.8 million, a reversal of an operating loss one year ago. Net income was $4.4 million ($0.07 per diluted share) versus a net loss of $8.8 million ($0.17 per diluted share).

That's a great GAAP report, but how did the company do in terms of the cold green? Let's walk over to the cash flow side of things. Here we see that net cash provided by operating activities grew by 95%, to $57.6 million. Free cash flow was $11.7 million, versus the consumption of nearly $9 million in the comparable quarter.

Now for the subscribers. Since the company seems to be operating well, future growth will theoretically be driven in large part by how many actual consumers it can snare. To that end, Netflix increased its paid-subscriber base by 61% year over year, to about 4.7 million movie lovers. As an added bonus, the churn rate dropped to 4.1% from 5%.

And how about this? On a year-over-year basis, margins have improved. According to the release, gross margin is now 33.8% compared with 27.1%, operating margin is now 2.1% compared with -6.4%, and net margin is 2% compared with -5.8%. (That 19.1% net margin observed in the previous quarter was affected by a tax benefit.)

Netflix is a healthy company right now, and it's proving that it might be a solid investment idea. Fools should also consider Netflix's stellar history as a competitor; it has so far successfully fended off threats from both Blockbuster (NYSE: BBI  ) and Wal-Mart (NYSE: WMT  ) . I do worry about the effect of video-on-demand on the company's future prospects, but since new recording formats will always be around the corner, I'd have to presume that there will always be a market for renting a physical disc of some kind.

There's one other thing with which I emphatically agree: Netflix should definitely see whether it can figure out a comfortable model for renting video games, as Rick Munarriz has pointed out. I think it could work, and I think it would only improve Netflix's chances as a long-term investment.

In the end, Netflix seems like a worthy idea for further due diligence. Its earnings and cash flow numbers check out in my opinion, and I think growth should continue. I was concerned with the EV/FCF ratio last time around, but I'm optimistic at this point, considering the change in the free-cash scenario and the fact that, based on a per-share price of $32, I calculate (according to analyst estimates) a PEG ratio of about 1.03. I may not be interested in subscribing to Netflix's service, but I nevertheless see its value from an investor's perspective.

Rent some related reading:

Netflix is aMotley Fool Stock Advisorrecommendation. For more stocks that get a thumbs-up from Tom and David Gardner, try out Stock Advisor free for 30 days.

Fool contributor Steven Mallas owns none of the companies mentioned. The Fool has a disclosure policy.


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