Netflix (NFLX -0.27%) is set to announce its third-quarter operating results on Tuesday, Oct. 20. And with shares having soared over 70% so far in 2020, there are clearly some high expectations for that report.
The streaming video giant tried to tamp down that optimism in mid-July by forecasting slower subscriber growth in the second half of 2020 as compared to the pandemic-influenced second-quarter surge. But investors still are hoping to see some good news around membership, profitability, and cash flow.
Keeping users engaged
In July, CEO Reed Hastings and his team were as blunt as they could be about predicting weaker revenue results ahead over the short term. Netflix's Q2 record 10 million subscriber additions likely was a temporary bump that pulled forward growth from the rest of the year, they explained. "Growth is slowing as consumers get through the initial shock of COVID-19 and social restrictions," executives said in July.
But investors are feeling more bullish about growth as the pandemic progressed through the late summer months. Most Wall Street pros are expecting to see significantly higher subscriber gains than the 2.5 million additions Netflix projected for the quarter that runs through late September.
While that headline figure is important, watch for any updates that management gives about user engagement. That's the metric that most closely correlates with changes in profit margin because it supports price increases. When users keep increasing their average daily streaming time, Netflix gains room to raise its monthly fees to reflect the improving value of the service.
The initial stages of the pandemic produced a unique window into Netflix's potential as a cash-producing powerhouse. When forced to dramatically scale back on new content spending as social-distancing efforts began, the streamer surged into positive cash flow. CFO Spencer Neumann suggested that this cash bonanza is a good indication of the strength investors can expect over the long term. The company might easily turn more than 15% of sales into free cash flow once it matures to full size and profitability, he said.
Tuesday's report should show worsening results on this metric, but that's not bad news for the business. In fact, Netflix plans to continue accelerating its content spending, which should help it pad its industry lead by lifting user engagement. The good news is that its expanding earnings profile has it on pace to reach positive cash flow territory on an annual basis sometime in the next few years.
The final 2020 outlook update
Assuming Netflix just meets its conservative Q3 outlook, it will be heading into the final quarter of the year with user gains of 28 million on a global base that started 2020 at 167 million. That pace would put the 200 million subscriber mark within reach over the short term. A surprisingly strong Q3 might even convince executives to project crossing that line before the end of this year.
That potential helps explain why investors are so excited about this growth stock despite the huge rally in the share price in 2020. It also raises expectations for Netflix to sound an optimistic tone on Tuesday as it rounds the corner on an unusually strong year for the business.