Please ensure Javascript is enabled for purposes of website accessibility

Why Coronavirus Doesn't Change the Long-Term Thesis for Netflix Stock

By Will Healy – Updated Apr 28, 2020 at 8:49AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

A temporary viewership bump does not eliminate the company's long-term issues.

Netflix (NFLX 1.39%) has become one of the few stocks to benefit from the COVID-19 crisis. As tens of millions join the ranks of the unemployed, consumers have turned to Netflix as a lockdown leaves people with more time to spend on the streaming video service.

This surge in business has taken this growth stock significantly higher. Moreover, as society opens, and the world slowly returns to work, the trends that drove Netflix higher over the last few weeks could easily reverse themselves. At that point, the previous problems that hurt Netflix stock before COVID-19 will likely return to the forefront.

Netflix appears unusually strong, at least at first

On the surface, Netflix looks like it is firing on all cylinders. For the first quarter, the company reported profits of $1.57 per share. While that might have missed estimates, it came in more than double $0.76 per share reported in the same quarter last year. Moreover, the $5.768 billion in revenue is a 27.7% increase from the year-ago figure of $4.521 billion.

Furthermore, the company saw an improved cash situation. Thanks in part to a production shutdown amid COVID-19, Netflix reported a non-GAAP free cash flow of $161.609 million. This came as a pleasant surprise as negative cash flow has long dogged the company. Given these improvements, one can see why Netflix stock has risen by almost 30% year-to-date.

NFLX Chart

NFLX data by YCharts

Also, analysts expect that earnings growth will continue. They predict that earnings will grow by 54.7% this year and by an average of about 35.9% per year over the next five years.

Investors also remember that coronavirus did not begin to hurt the economy until mid-March, very late in the first quarter. This indicates that investors may have to wait until the release of the second-quarter numbers to see the full extent of the COVID-19 bump.

Old problems remain

Though Netflix has reported positive net income for years, the financial state of the company has continued to worsen. The need to compete with the likes of Disney, Amazon's Prime Video, AT&T's WarnerMedia, and others has led to billions in content spending. While this may widen Netflix's competitive moat, it also comes at a high price. In 2019, the company reported $1.867 billion in net income. However, in that same year, long-term debt rose from $10.360 billion to $14.759 billion.

Debt levels fell to $14.171 billion in the first quarter of 2020. Many had hoped that this would show Netflix had found a way to profit while financing its massive content costs. However, the day after the earnings report, Netflix announced a debt offering of $1 billion worth of dollars and euros. Hence, the recent subscriber bump did nothing to reduce the company's dependence on a growing debtload.

Girl watching a movie on her laptop with a bowl of popcorn nearby.

Image source: Getty Images

Look for the return of the status quo

Now, as businesses look to reopen across the world, people will probably spend less time on the Netflix platform. Management admitted as much in its report, saying that they expected a decline in viewership and slowing membership growth as home confinement ends.

As this occurs, investors may again take notice of a balance sheet that continues to weaken. Once liabilities are subtracted from assets, Netflix's equity only amounts to $8.409 billion. Not only does that fall short of the amount of long-term debt, but it also grows at a slower pace than debt obligations. This also means at some point, Netflix may have to slow its content spending, even amid increasing competition.

Moreover, with a forward P/E ratio of 69.5, this growth appears priced into the stock. Additionally, that growth probably depends on Netflix maintaining its current pace of spending. If borrowers become increasingly reluctant to loan the company money, profit growth will likely slow along with content creation.

Should this happen, it is unclear how the company could raise more revenue outside of customer growth. The standard plan for Netflix costs $12.99 per month. Other than HBO Now, Netflix prices itself higher than competing services. Disney offers three streaming services for that price, and Amazon also charges less for Prime Video. For this reason, Netflix could also struggle to retain its current fees if the quality of its programming drops.

No obvious new catalysts for Netflix stock

Netflix has benefited temporarily from COVID-19, and some of that benefit will likely disappear as the world reopens. Still, as long as it can maintain the quality of its content, Netflix should also continue to post impressive profit growth.

However, as its customers return to work, the concerns about rising debt and a deteriorating balance sheet could return to the forefront. Without any further obvious catalysts, Netflix investors have no apparent reason to bid the stock higher.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Will Healy owns shares of AT&T. The Motley Fool owns shares of and recommends Amazon, Netflix, and Walt Disney and recommends the following options: long January 2021 $60 calls on Walt Disney, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
NFLX
$240.02 (1.39%) $3.29
The Walt Disney Company Stock Quote
The Walt Disney Company
DIS
$100.04 (-0.75%) $0.76
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$120.30 (-0.54%) $0.65
AT&T Inc. Stock Quote
AT&T Inc.
T
$15.32 (-2.12%) $0.33

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
338%
 
S&P 500 Returns
108%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.