Netflix (NFLX +0.34%) was the best-performing stock in the S&P 500 in 2015, more than doubling over the course of the year. However, 2016 has not been as kind to the streaming video pioneer. Netflix stock is down about 18% year to date, with most of that decline coming since Netflix released its Q1 earnings report in mid-April.
Netflix Stock Performance, 2015-present; data by YCharts
Netflix shares ended last week at $93.75: 30% below the all-time high set in late 2015 and roughly in line with where they traded a year earlier. The company still has a stratospheric valuation -- but Netflix stock is starting to look enticing for long-term investors.
Domestic revenue and profit are growing quickly
One key reason why Netflix stock has fallen in the past two months is that investors are starting to worry about saturation of the domestic market. Indeed, in April, management projected that Netflix would add only 0.5 million domestic streaming subscribers in Q2, down from 0.9 million a year earlier.
Still, Netflix added more than 2.2 million domestic subscribers last quarter: roughly in line with its Q1 2015 performance. It's not like growth is crashing to a halt. Furthermore, revenue and profit from the domestic business are poised to continue growing at a high rate for the next year or two due to rising average revenue per user.
Netflix began to raise the price of its most popular domestic streaming plan in May 2014. At the time, it promised to let existing subscribers keep their $7.99/month rate for two more years.
The two year anniversary of that price increase has now passed. However, Netflix decided to phase in the $2/month price increase over the rest of this year, rather than raising the price for an estimated 17 million subscribers simultaneously. This will allow Netflix to check that the price increase isn't driving mass cancellations before rolling it out broadly.
By the end of 2016, nearly all of those 17 million longtime subscribers will be paying an extra $2/month to Netflix, bringing in about $400 million of incremental annual revenue. That should more than cover the increased content costs from Netflix's exclusive deal to show Walt Disney movies soon after they leave theaters. This valuable content could help Netflix lure new subscribers.
New content could help Netflix attract more subscribers. Image source: The Motley Fool.
Last quarter, Netflix's domestic revenue and contribution profit rose 18% and 32%, respectively. The "un-grandfathering" of Netflix's subscriber base should keep domestic revenue and profit growing at a similar rate at least through the end of 2017.
International growth is in the early innings
Earlier this year, Netflix became available in every major market in the world, except China. However, this was really a "soft launch." Over the next several years, Netflix will have to do a lot of work to add local language support, license and produce more local content, and market its service in each of the 130 countries it entered back in January.
All of those things are expensive. As a result, Netflix expects to continue burning cash at a rate of about $1 billion per year through the end of 2017. However, while new markets take time to ramp up, they typically turn profitable after about three years and have the potential to grow for many years thereafter.
Netflix's international segment was on the verge of turning profitable in mid-2014 before the company began its most recent wave of growth. This hints at Netflix's long-term potential outside the U.S. By 2020, all of its markets should be maturing and its international operations as a whole should be solidly profitable.
Netflix is more profitable than it seems
Netflix bears' main argument is that the stock is far too expensive. Indeed, Netflix stock trades for 90 times the company's projected 2017 EPS -- and about 350 times its projected 2016 EPS.
However, Netflix's underlying profitability is masked by the immense amount of money it is investing in international growth. Last quarter, Netflix's international contribution loss totaled $104 million: more than $400 million on an annualized basis.
Furthermore, Netflix's technology, development, and other overhead costs totaled $331 million last quarter: up from $166 million two years earlier. This represents a $660 million increase in the annual run rate. Much of that can be attributed to the company's aggressive international expansion over the past two years.
In a worst case scenario, Netflix could abandon some or all of its international markets. It would then save hundreds of millions of dollars in international-related technology, development, and overhead costs in addition to the $400 million annualized international contribution loss it has been incurring lately. This would likely add $1-$1.50 to Netflix's EPS.
Netflix stock is for patient investors
Of course, Netflix is not likely to boost its earnings by abandoning international growth. But that's because it expects to generate huge profits from its international business after it matures -- far greater than the short-term profits it might realize by exiting unprofitable markets today.
Netflix stock is still quite expensive. But if you believe that Netflix's success in the U.S. and its early international markets can be repeated in many other countries, the recent pullback could make this a good time to invest in Netflix. Thus, while I've been very skeptical about Netflix stock in the past, I'm adding it to my watch list now due to its vast global growth opportunities.
