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Here's Why Netflix's Soaring Profits Will Likely Accelerate

By Danny Vena – Feb 21, 2020 at 10:30AM

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This is just the beginning of a multiyear transition.

Netflix (NFLX -4.49%) has been a runaway train for long-term investors, gaining more than 32,000% since its IPO in 2002 and nearly 4,000% in just the past decade. Among the most frequently cited reasons for not buying the stock are that the best gains have already been achieved, the company's ongoing cash burn, and the paltry profits the streaming giant has generated.

Over the next couple of years, however, Netflix could begin to throttle back on its massive content spending, reversing its cash burn and dramatically ramping up its profits. This combination of factors could provide a turbo-boost for Netflix stock and result in further gains for investors.

Two hands counting money over business charts on a desk.

Image source: Getty Images.

Its impressive growth continues

In the fourth quarter, Netflix reported revenue of $5.47 billion, up nearly 31% year over year. At the same time, its diluted earnings per share (EPS) of $1.30 surged 333% year over year, up from just $0.30 in Q4 18. While the top-line growth is partially the result of price increases in 2019, it's also tied directly to the company's growing subscriber base. In fact, some believe Netflix has a clear path to doubling its subscriber base by 2025.

The company added 8.76 million net new subscribers during the fourth quarter, achieving record additions in the Europe, Middle East, and Africa (EMEA), Latin America (LATAM), and Asia Pacific (APAC) regions. During 2019, the company added nearly 28 million new customers, with millions more joining every quarter.

Increasing profit margins

If you're looking for proof that Netflix can consistently ramp up its profits, a look at its operating margins over the past several years tells the tale. For full-year 2019, Netflix delivered operating profit of $2.6 billion and profit margins of 13%, up from 10% in 2018, 7% in 2017, and 6% in 2016. In fact, the company has hit its target each year since it began providing full-year operating margin guidance back in early 2016.

Netflix said it's targeting a 16% operating margin for 2020, and if history is any indicator, the company should have no trouble reaching that goal.

A significant improvement in cash burn

The company seemingly has the ability to throttle up or back on its content spending and repeatedly said that 2019 represented peak cash burn. In its Q4 shareholder letter, Netflix said (emphasis mine):

For the full year, FCF [free cash flow] was -$3.3 billion, which we believe is the peak in our annual FCF deficit. Our plan is to continually improve FCF each year and to move slowly toward FCF positive. For 2020, we currently forecast FCF of approximately -$2.5 billion. 

A positive change of nearly $800 million is a big improvement. The company went on to say that, with its improving FCF, over time it would be "less reliant" on the debt market and able to fund its original content spending with its growing operating profits.

Analysts are at odds over exactly when the tech giant will turn cash flow positive, but many expect that day to come sometime over the next several years. Cowen analyst John Blackledge has gone on record predicting the company will generate free cash flow positive of $305 million in 2021. Neil Begley of Moody's is forecasting Netflix will be cash flow positive by 2023

A woman on an exercise bike watching Netflix original program Orange Is the New Black on a tablet.

Image source: Netflix.

Investor takeaway

Netflix continues to demonstrate its ability to create programming that attracts a growing number of subscribers across the world, which, in turn, spurs its top-line increases.

With this combination of strong revenue growth, increasing profit margins, and slowing cash burn, Netflix is setting the stage for its profits to explode, which will usher in the next phase of the company's stock growth.

Danny Vena owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.

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