Netflix (NFLX +0.89%) shareholders can expect a volatile week ahead for their stock. The streaming video giant is due to report first-quarter earnings results on Monday, April 16. And, with shares having doubled in the past 12 months, it's fair to say that Wall Street has built up high expectations around that announcement.
There are good reasons for the optimism. In late January the company revealed that membership growth sped up to 24 million members in 2017 from 19 million in the prior year. Profits surged thanks to increased subscription prices. And CEO Reed Hastings and his team have forecast continued accelerating gains to kick off the new fiscal year.
Image source: Netflix.
Blame it on content
Management's prediction calls for the addition of 6.35 million paying members this quarter to mark a big improvement over the prior year's 4.95 million. The U.S. market should grow at a steady pace, but Netflix believes gains in its maturing international segment will jump to 4.9 million from 3.5 million a year ago.
If it hits or exceeds that aggressive goal, the streamer will credit a few standout original-content releases. The fourth season of Black Mirror likely moved the needle, but Altered Carbon, another science fiction series, probably had an even bigger impact. It was the single most-searched-for TV show in February, according to Google Trends. Meanwhile, Netflix's Wild Wild Country documentary might have generated enough buzz to impact subscriber engagement and warrant a mention in Hastings' quarterly shareholder letter.
Profits and cash flow
Netflix has been hiking membership prices across its global markets, and bears claim that these increases reflect a shaky operating approach that relies on unsustainable content spending to bring in new subscribers. Yet monthly pricing just reflects added value for the TV service. Average streaming time per user rose 9% last year, or the same pace by which membership prices increased.
Combine soaring user gains with higher average spending and you have solid support for rising profitably. In fact, Netflix is targeting operating margin of 10% in 2018, up from 7% last year and 4% the prior year. The biggest contributor to profits this quarter will be the international segment, in which earnings should shoot up to $234 million from $135 million last quarter and $43 million in the year-ago period. Overall, profits should expand to $0.63 per share from $0.40 per share last year.
Netflix's cash outlook isn't nearly as bright, with outflow set to balloon to almost $500 million this quarter from $344 million. The company is expecting to burn through as much as $4 billion for the full year, or about twice the total from 2017.
NFLX Cash from Operations (TTM) data by YCharts.
The long-term plan is to reach positive cash flow once membership growth stabilizes. For now, though, management is happy to scale up its content spending as long as subscriber numbers are surging.
Risk and return
More of that spending is going toward the production of shows and movies, and so business risk is rising. Netflix pays cash up front for this content, after all, and there's always the possibility that a show fails to resonate with TV fans. For example, Netflix took a $39 million charge last quarter for content that management decided "not to move forward with." Given the multiyear development schedule, impairments might also be driven by a smaller-than-expected membership base when a movie or show finally reaches its servers.
But since it kicked off its original-content strategy five years ago, Netflix has demonstrated a knack for procuring series and movies that attract new subscribers and get existing members to spend more time on the service. I'd expect recent releases like Altered Carbon to extend that momentum and keep Netflix on its high-growth, high-spending path well past the current quarter.
