It won't be long before Netflix (NFLX -0.31%) starts generating positive cash flow. That's the prediction management stands by, despite the fact that cash trends are worsening to a $3.5 billion loss this year compared to $3 billion in 2018. Netflix plans to achieve this difficult turnaround even as annual subscriber growth slows for the first time in four years.
That cash flow forecast isn't as absurd as it might seem at first blush, though. Let's take a look at a few reasons it's a mistake to bet against CEO Reed Hastings and his team on this ambitious cash flow prediction.
1. Past promises kept
First, Netflix has a good track record for fulfilling its long-term financial targets. In early 2017, when the company started projecting what management called "steady" growth in operating margin, that figure had stood at 4% for the past two years.
Yet Hastings told investors to expect the rate to increase by 3 percentage points to 7% in the fiscal year ahead. Management hit that target a year later and projected another 3-percentage-point increase in 2018. Combined with the 35% revenue increase, hitting that goal allowed operating profits to almost double to $1.6 billion last year. Hastings and his team are projecting that margins will improve to 13% this year and to 16% in 2020, and the streak of wins here should give shareholders confidence in the company's other ambitious forecasts.
2. More ammunition on the way
Netflix's growth rate in the U.S. is being hurt by its latest fee increase, meaning there's a limit to the TV giant's pricing power given the amount of time users want to engage with its streaming service today. The downside of overshooting with those subscription costs is that membership gains are slowing, and that's why the growth stock sees annual global additions trending down in 2019.
Yet there's a massive financial benefit to having its 60 million-plus U.S. members paying an average extra dollar each month. Revenue is growing faster than the subscriber base, up 27% over the last nine months. Netflix might not have room to raise prices again for at least another year, and Hastings said in a conference call that management plans to "give it a pause and focus on the value" of the service, especially through blockbuster movie releases. The good news is its last increase, plus the migration toward high-definition plans, will generate plenty of extra cash over the next few quarters anyway.
3. Competition won't derail subscriber growth
Netflix's latest prediction calls for membership gains to land at just under 27 million in 2019 compared to 29 million last year and 24 million in 2017. While that forecast assumes some bumpiness from the welcoming of Disney and Apple into the streaming market ("The launch of these new services will be noisy," executives said), it still translates into almost 8 million new signups, including 600,000 additions in the mature U.S. market.
Into 2020 and beyond, Netflix sees all the streaming services competing more with broadcast TV than with themselves. But even if you do believe the competition will hurt the industry leader, there won't be a disruptive exodus from the platform over the next year or so, especially as prices hold steady. Even sluggish subscriber growth should give Netflix the ammunition it needs to begin improving its cash outflow in 2020, with an eye toward slowly moving toward positive flow over the next few years.