The video streaming landscape has become bloated and overcrowded. Not too long ago, streaming pioneer Netflix (NFLX -0.51%) was the biggest player in town. However, over the last few years, more companies have entered the space. Some of these include niche players like fuboTV, while others, like Disney, may be late to the game.
Given how crowded the streaming market has become, these media companies seem to be competing for the same cohort of viewers. And in an age where instant gratification is an absolute must-have for viewer entertainment, many of these companies have little choice but to spend top dollar on content and marketing.
Netflix recently reported first-quarter earnings, and the results were mixed at best. Wall Street seems divided, and investor enthusiasm may be waning. Let's unpack the report and assess what's going on.
What is Wall Street's feedback for Netflix?
Following Netflix's Q1 report, Wall Street analyst expectations seem to be all over the place. Jefferies lowered its price target from $415 per share to $405 per share. Even with the price target reduction, the bank still sees over 20% upside from current trading levels.
On the other hand, Piper Sandler and Rosenblatt Securities increased respective price targets and see about 8% upside. However, despite the forecasted price increases, both research firms have a "neutral" rating on the stock. Lastly, Benchmark believes Netflix stock could fall another 24% and has a sell rating on the stock.
What's interesting is that in late 2022, Wells Fargo and Cowen both raised their respective price targets for Netflix stock. At the time, Cowen raised its price target from $340 to $405, whereas Wells Fargo increased it from $300 to $400. Just a few months have gone by, and neither firm appears to have revised or issued new research following the Q1 report.
Image source: Getty Images.
Q1 at a glance
For the quarter ended March 31, Netflix reported revenue of $8.1 billion, up 4% year over year. The company's operating margin came in at 21%, which was down about 4% compared to Q1 2022. The primary driver behind this margin deterioration was from cost of goods sold and technology and development costs, which rose 12% and 5%, respectively.
Per Netflix's 10Q filing, cost of goods sold was driven by a material increase of nearly $300 million from content amortization, which relates to the company's content library. It's important to note that not all of Netflix's cost of goods is considered amortization. However, the company does not break out on its income statement what is considered amortization and what falls under categories such as personnel costs or general production-related expenses. For this reason, in order to get a real sense of the company's spending habits, investors should take a hard look at cash flow.
The cash flow statement illustrates that despite the lower margins, Netflix did a decent job tightening its cash expenses. The company reported free cash flow of $2.1 billion in Q1, compared to $800 million in Q1 2022. The increase in cash flow directly affected the balance sheet, as Netflix ended Q1 with $6.7 billion of cash and equivalents compared to $5.1 billion in December 2022.
Investors should know that management made it clear that the rise in cash flow can be attributed to lower-than-expected cash content spend. However, the company doubled down on its cash content spend for 2024, which is forecasted to be around $17 billion.
So, even though Netflix is under budget for its content spend so far this year, the company still plans to use excess free cash flow to invest in the business. This could be argued as being a questionable strategy, especially given that Netflix whiffed on Q1 subscriber growth. The company added 1.75 million new subscribers; whereas, Wall Street expected closer to 2 million. And let's not forget, Netflix is coming off a hot fourth quarter during which it added a whopping 7.7 million new subscribers.
Is it time to panic?
Investors rarely benefit when they panic. But to be blunt, valuing Netflix is becoming an increasingly arduous exercise. In any given quarter the company could be adding a record number of subscribers, or losing customers on a net basis. As long-term investors, it is important not to get too swayed by each individual quarter. Rather, as long as the growth thesis remains intact, the stock is likely going to be a solid performer for your portfolio.
For this reason, Netflix's earnings power is extremely hard to predict. This means that in any given quarter, profits and cash flow could be virtually anywhere. Subsequently, traditional valuation metrics like price-to-earnings (P/E) could imply that the stock is undervalued in one quarter and overvalued the next. As of the time of this article, Netflix's P/E is 33, which is more than double the long-run average of the S&P 500.
For me, Netflix's Q1 results did not do enough to convince me to buy the stock. Moreover, the underlying fundamentals of the business make it hard for me to justify that it is worth trading at such a premium compared to the broader markets. I view the streaming landscape as increasingly tough to compete in, and spending more on content does not provide enough conviction that Netflix will acquire more users at a robust pace and maintain healthy margins.
