What happened
Continuing Friday's sell-off, shares of Netflix (NFLX 0.68%) stock sank 5.2% through 9:55 a.m. ET Monday after the stock suffered a downgrade at the hand of NYC-based equity research firm CFRA.
As StreetInsider.com reported this morning, CFRA cut its rating on Netflix from hold to sell with a $238 price target. After this morning's sell-off, share shares cost $229 and change.
So what
Granted, a $238 price target on a stock that costs $9 less than $238 seems to suggest that CFRA should be recommending you buy Netflix rather than sell it. But as the analyst points out, a lot of the upside in Netflix has dissipated thanks to the stock's 40% run-up in price since the middle of July. Now the greater risk is that Netflix will start missing expectations and start to give back its gains from the past month.
NASDAQ: NFLX
Key Data Points
What could go wrong? Well, consider that Netflix lost 200,000 subscribers in Q1 and another 1 million subscribers in Q2. Netflix is promising to win those 1 million back in Q3 -- but what if it doesn't? What if the trend of increasing subscriber losses continues rather than reverses in Q3? That obviously won't be good news for the stock.
Moreover, while it's true that Netflix is mooting a plan to create an ad-supported subscription tier, this isn't expected to kick in until sometime in 2023 -- and there's no guarantee it will prove a popular option if it does, or reverse the slide in membership. In any case, ad-supported subscribers won't be arriving for at least the next six months, and in CFRA's view, that means there's little reason to own Netflix stock until then.
Now what
And there are other things that could go wrong for Netflix.
Consider that while Netflix generated about $800 million in positive free cash flow in Q1, that number collapsed to just $13 million in Q2. While earnings as calculated according to generally accepted accounting principles (GAAP) still look strong -- $3 billion in the year's first half -- and the stock doesn't appear particularly expensive on a P/E basis (just 21 times trailing earnings), Netflix's crumbling free cash flow could erode reported earnings.
CFRA, for one, is "confident EBITDA and EPS will be lower in 2022 2H compared to 1H results," which could panic investors next quarter regardless of how the subscriber numbers look. Today, it seems investors aren't interested in waiting around to see if CFRA is right. They'll sell now and ask questions later.
