Netflix: Bull vs. Bear

In this Motley Fool Money podcast, Motley Fool analyst Jason Moser discusses:

• Alphabet's (GOOG 1.03%) (GOOGL 1.08%) board approving a $70 billion share-buyback plan.
• Alphabet CFO Ruth Porat's continued strong performance with the company's capital allocation.
• How Chipotle's (CMG 0.86%) pricing power boosted its first-quarter results.
• What Chipotle's plan for opening new locations suggests about where the chain will go from here.

Also, Motley Fool analysts Jim Mueller and Bill Mann square off in a "Bull vs. Bear" debate over Netflix (NFLX 2.56%).

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on April 27, 2022.

Chris Hill: Today on Motley Fool Money, a Bull vs. Bear debate over Netflix, and I'll look at Chipotle's future. I'm Chris Hill, joined once again by Motley Fool senior analyst Jason Moser. Thanks for being here.

Jason Moser: Hey, thanks for having me.

Chris Hill: We're going to start today with one of the most consequential companies in the world, and that is Alphabet. And I get that first-quarter profits and revenue were a little lower than expected. I don't get the hand-wringing that I'm seeing from some corners in the financial media and the analyst community. They had $68 billion in sales in the first quarter.

Jason Moser: Yeah.

Chris Hill: Which, I guess, technically, that is lower than the expected $68.1 billion, but it's 23% revenue growth compared to a year ago for a company this size. Come on!

Jason Moser: I'm glad you put it that way. It's often, maybe, pay less attention to those targets that analysts said and pay more attention just to how the business is doing. When you look at how Alphabet's business is doing, it's hard to argue that it is not doing well. [laughs] As you mentioned, if you exclude currency effects, revenue growth is 26%, operating margins steady at 30%. I think the attention-getter, probably, and maybe some of the hand-wringing comes from the YouTube segment of the business. The YouTube advertising revenue -- that came in at $6.87 billion versus the expected $7.51 billion. That's what was expected. That's an arbitrary target. But if you look at the performance of the business from a year ago, that $6.7 billion was up from $6 billion a year ago. So it did grow, it just maybe didn't grow as quickly as others might have expected, but there were some reasons why.

There's been some modest performance in direct response. They continue to witness some headwinds there in the direct response side of the business. And they have noted that there is some concern out there, some pulling back on advertising budgets. We are seeing a little bit of a slowdown in ad spend, but also part of it was just a really tough comp from a year ago. They made the point in the call that the largest impact from COVID on the business's results within the second quarter of 2020. Ultimately, what that means is that they've set the table here for a relatively tame current quarter as well, as it's going to be going up against another really tough comp.

Now, with that said, we start to see things normalize a little bit more going forward. This is still the same awesome business that we've always talked about here. When you look at the utility of the platform -- the service, the value that you get from what they provide. I mean, search is just crucial. But it's so much more than just search. When you have YouTube, you have Maps, you've got a hardware division, you got Cloud -- just so many pieces that go into making up this business. As a shareholder myself, I look at this quarter -- I say, you know what, they keep bringing those in, I don't mind, because you want to bring that share price down, make it a little bit more attractive for people to maybe add a couple of shares to their portfolio, I think it's a reasonable time looking at this business because it's now trading at around 20 times full-year earnings estimates. And that's on top of already setting some fairly tame expectations. This is looking like a better opportunity every day.

Chris Hill: Ruth Porat, the chief financial officer, talked a little bit about how ... in response to YouTube, their subscription business is growing. That's certainly something to keep an eye on. They're investing in cybersecurity, which you would expect them to do. They got a share-buyback plan that was just approved by the board of directors: $70 billion. That is some serious cake, [laughs] just in terms of what they have done previously with share buyback plans, but I think that, among other things, speaks to the confidence they have in the business.

Jason Moser: Yeah, I think you're right. When you look at the numbers that they lobbed up there. YouTube now with over 2 billion monthly signed-in users. They noted Google Maps searches for "shopping near me," those searches were up 100% globally from a year ago. You've got just so many different facets of this business that continue to perform so strongly. They are capitalizing on short-form video. That was up 4X from a year ago. Yeah, all things considered, this is a business that produces a lot of cash. It's pretty darn reliable. And that $70 billion repurchase authorization, it sounds like a really big number -- I mean, it is. If you look back to 2017, since 2017, they've spent close to $130 billion total in share repurchases. Oftentimes with these tech companies, a lot of those repurchases just go to offset dilution. And that has been the case somewhat here, but it is worth noting the share count's down 5% since 2017. I suspect that that'll be one more thing that can help contribute a little bit more to shareholder value there.

Chris Hill: Is it safe to assume that Ruth Porat, if she's not the architect of the share-buyback plan ... we've talked about her in the past, as among other things, she keeps a close eye on the "Other Bets" spending that they do, and in some cases has reined it in. Maybe if you're in the Other Bets division at Alphabet, you're like, "Hey, maybe we can get some of that $70 billion to try some new things?" But I don't know. I just have a hard time arguing against the job that she is doing.

Jason Moser: I would not argue against the job that she is doing. I'd take solace in knowing that she's a part of this team. She's just very thoughtful on how the company allocates capital. I do appreciate the fact that while they have that Other Bets segment of the business, and that's a neat thing to think about -- moonshots, and all the different kinds of things that could come from that. The reality of the situation, it's an incubator. It loses a lot of money, but it can come up with some really cool ideas. Waymo could be one of them. But it does feel like she does a really good job in balancing the needs of the business all the way around, from what they need to be able to invest in their workforce, in their core offerings, to making sure that that Other Bets side of the business still gets what it needs and what it deserves. And then also keeping shareholders in mind as well, and making sure that these types of big share repurchase authorizations actually do go to help return some value to shareholders.

Chris Hill: Chipotle's first quarter demonstrated, among other things, that this is a business with pricing power. Labor costs are going up. The costs of beef, avocados, paper products, they're all going up. But Chipotle is able to raise prices on the menu, and first-quarter profits came in higher than expected. Same-store sales up 9%.

Jason Moser: Yeah, another very impressive quarter, particularly in a difficult stretch, and I think it's really difficult to overstate the value that Brian Niccol has brought to this company during his tenure. He's so on message. He keeps Chipotle at the forefront of the conversation, but he's not putting them up on a pedestal like Ells used to do back in the day. Because that's just setting yourself up to be knocked off at some point, which -- they've been knocked off that pedestal a couple of times. But you feel like it's just he doesn't take anything for granted. He knows that he needs to work for it every day. Maybe that's just a part of where he came from. Coming from Taco Bell, I'm sure that was a little bit of a different experience, but he just continues to execute. Sales for the quarter, they were up 16% to reach $2 billion. Comps up 9%, as you noted. Restaurant-level margin did fall. They saw a decrease in restaurant-level margin, I think 160 basis points versus a year ago as input costs do continue to weigh on the business. They've noted inflation in workforce costs -- that continues to weigh on the business, but they are able to flex that pricing-power muscle a little bit. They noted that they did raise prices over 4% at the end of the quarter, and ultimately, consumers are still willing to pay it, which is a good thing. But, yeah, just another really impressive quarter for a company that just managed its way through the last couple of years so effectively.

Chris Hill: Well, and when you think back, this quarter includes January --  you think of [the] omicron variant being on the rise and peaking in January and February. Some parts of the U.S. dealing with bad winter weather. You go back, Chipotle warned that was going to affect results. So the fact that they put up same-store sales growth of 9% despite all that is impressive. If anyone is wondering where this business is going, they opened 51 new locations in this past quarter, and most of them were built with those digital-only drive-through lanes.

Jason Moser: They expect to open between 235 and 250 new restaurants this year, with at least 80% including a Chipotlane. To your point there in regard to January and February, in-store sales grew by 33% from a year ago. The consumer still was really happy to get back out there. That was a little bit more tilted maybe toward the end of the quarter, but nevertheless, digital represented 42% of sales. They've struck a nice balance there with the business, and they continue to experiment with the menu. They noted that the pollo asado, which has gotten a great response -- and I will say as a consumer, I tried it, it's really tasty; if you've not tried it, I recommend it -- they say that's their first chicken innovation in 29 years. I had to think back on that. Is that actually true? I guess it is, because other than just your plain-Jane chicken burrito, I guess they haven't really done much on the chicken side of things. It's just neat that they can get out there and try new things at will. They're working on another menu item that they're really excited about now.

Closing in on 28 million rewards members now. And I'm one of them, Chris, and I'm going to go to redeem some of those points tonight for the family. But they are targeting 7,000 restaurants in North America still. That sounds like a lot when you compare it to the 3,000 or so that they have today. Now, whether they can get to 7,000 -- that's still a question mark. I tend to look at that, maybe discount it back a little bit to be a little bit more practical. That's still a long runway of growth, particularly when you add those Chipotlanes into the mix. I think that, for this business, really, the big question... I mean, now, it's 45 times full-year earnings estimates, which is not bad considering how many restaurants they think they can still open. I think the wildcard really, right now, for this business is just the inflationary environment and how much more they can potentially raise prices, because you can't do that forever. There is a point where consumers will say, "No, I'm going to go somewhere else."

Chris Hill: Jason Moser, great talking to you. Thanks for being here.

Jason Moser: Thank you.

...

Chris Hill: In the past 12 months, shares of Chipotle are flat, which is basically what the overall market has returned as well. Shares of Netflix, on the other hand, are trading 60% lower than a year ago. So is this a buying opportunity or is Netflix past its prime? To kick off today's debate, here's Ricky Mulvey.

Ricky Mulvey: This is Bull vs. Bear. We take a company, we find some analysts, and we flip a coin to decide which side they take. Today, the company is Netflix and in the bull corner, we have Jim Mueller. Jim, good to see you.

Jim Mueller: Hello, Rick.

Ricky Mulvey: In the bear case ... you know, it's usually in bad taste to knee the head of a down opponent, but Bill Mann will be giving the bear case for Netflix right now. You excited?

Bill Mann: The king of bad taste.

Jim Mueller: He's going to enjoy this one, I can tell. [laughs]

Ricky Mulvey: So we'll have about 4 minutes for each side and then you get to decide who the winner is by voting in our pool, @MotleyFoolMoney on Twitter. Jim, whenever you're ready with the bull case, you can get started.

Jim Mueller: So we all know Netflix, the leader and the first advantage mover of online over-the-top streaming. Video content on demand. Entire seasons all at once and all that stuff. For a very long time, that's been working just perfectly. In the Before Times, the thesis was simple: High growth of subscribers -- 20%, 30% a year for 8-plus years, since they really went all-in on streaming. That means more revenue every year, which means the ability to spend more on the content, which means if the content is good, they get more subscribers.

For a very long time, that flywheel worked very, very well. Along the way, management met and dealt with problem after problem, especially the Qwikster one back in 2011, where they basically doubled the revenue of the company by splitting the DVD service and the streaming service, and started charging for both. They overcame the hassles that came with that.

Actually, that was the last time until just this past quarter that the company had seen sequential decline in subscriber growth. Now, since we've been coming out of the pandemic, we've had five quarters in a row of less than 20% subscriber growth year over year. For the last four quarters, ending in the most recently reported Q1 2022, less than 10%. This last quarter, technically, they had a sequential decline. They lost 200,000 subscribers, but we knew there was going to be a Russian effect. Russia contributed a 700,000 subscriber loss to that. But that was still a bad miss against the management expectations of 1.8 million subscriber growth, backing out Russia. So management is forecasting another decline for this current quarter, Q2. So that has a lot of the bull side scratching their head and saying, "Is that old thesis still going? Or do we have to figure out what the company is going to be doing next?"

I think it's the latter nowadays. I still have confidence in management. They have a long history of meeting and overcoming problems. But this is going to be a big problem that's going to take some time to figure out. They have a couple of different paths ahead. They could just pull back a touch on the content spending and become a cash-flow-generating machine, kicking out billions and billions of dollars in free cash flow, hold sub count steady or grow [it] slowly. We saw how that looks back in 2020 when they had to cut back production in the middle of the lockdowns. They generated $2 billion of free cash flow that year.

They could use that to buy back shares, grow earnings per share, and grow their share price that way. Or they could look around for other sources of revenue growth. They mentioned in the last quarter, password sharing -- they're going to crack down on that, but that's just a one-time boost. They've been investigating games and could possibly turn that into a revenue stream. Advertising -- they're going to look into that, offer an ad-based tier subscription, generate revenue from that. Of course, there's always licensing and merchandising, basically doing the Disney play. Management has indicated they're going that route. It won't be a fast fix. So don't expect multiples and 50% growth in one year that they've had in the past. But I'm trustful of management, that they will be able to figure out what they'll do. They've earned my trust in the past. They've been very upfront with shareholders, very honest. Haven't shied away from recognizing problems and telling people how they're going to try to fix them. They've shown to be good at pivoting. So I think they can do it again going forward.

Ricky Mulvey: Bill Mann, you lost the coin toss. You elected to go second with the bear case. What do you got?

Bill Mann: I'm interested how I ended up getting to choose which side I wanted to go after I lost the coin toss. But I guess I lost the coin toss because I am the bear for Netflix, and you're right. This is a very, very important company in The Motley Fool's history. This is a company that we have recommended many times and it has been a fabulous company for us and for our shareholders. But you have to ask where we're going to from today. Netflix has gone from an open-skies market to a Lord of the Flies market, where they are now in a competition with well-heeled, incredibly deep-pocketed competitors who are putting out great content from their own libraries.

There's a statistic from this last quarter that I think really nails down exactly where Netflix is and where the challenge is for them. They spent $556 million in marketing -- $556 million, that's a half a billion [dollars] in marketing -- and their subscriber base shrank. Which means if they paid people $100 to sign up, that would be 5.6 million new subscribers. Their churn was incredible. It had to have been this last quarter. It currently is still also the most expensive of the streaming services.

So I think you have to ask yourself: With Netflix's position where they are now in a highly competitive market, is it any longer the default choice for subscribers? What we've heard over years was that subscribers would have Netflix plus one or two other subscription services. I think that what we're seeing now -- and I think the numbers from the company's marketing costs really bear this out -- is that it's not even that they are losing to what are called "streaming tourists," the people who sign up when they want to watch something and then cancel when they're finished. They're losing to their competitors. It is no longer Netflix plus a few. It's a few and maybe Netflix. Their cash burn is growing. They are pushing very hard to retain subscribers, at least in part because of the cash burn, at least in part also because of the incredible amount of money that they are spending for new content. So Netflix, it would not surprise me... I think very highly of their management team. They have been trailblazers in the past. They've done things that people didn't believe were going to work, but they have not done them in an environment where they're going up against Disney. They're going up against Discovery. They're going up against Amazon. They're going up against CBS and Apple. I think it's too much too in terms of competition for Netflix to be assumed to be the default anymore, and so then you have to question why it is that subscribers in their millions would continue to pay a premium.

Ricky Mulvey: Thank you, gentlemen. You can decide who made the better argument @MotleyFoolMoney on Twitter. We'll have a poll up there and you check the results. Thank you.

Chris Hill: Like Ricky said, we've got a poll on Twitter @MotleyFoolMoney. You can cast your vote for who made the stronger argument on Netflix. As always, people on the program may have an interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. See you tomorrow.