Netflix (NFLX 1.27%) shares have nearly doubled over the past year, but that doesn't mean that there aren't some non-bulls out there who need convincing. Maybe they will listen to Baird analyst Vikram Kesavabhotla, who has upgraded the streaming service stock to outperform from neutral, impressed by its near-term prospects after last week's financial update.
If you like a good plot twist -- and Netflix viewers probably enjoy a good plot twist -- Kesavabhotla's newfound love for the stock after Wednesday afternoon's second-quarter report is unique. The shares actually surrendered more than 10% of their value in the two trading days following the earnings release.
However, the Baird analyst has his reasons and he's also boosting his price target from $340 to $500, implying 17% of near-term upside from current levels. Will Netflix recover from its initial earnings dip? Let's take a closer look at the challenges and opportunities that the wold's most popular premium streaming video service faces on the potential path to $500.
Channel surfing without wiping out
Kesavabhotla's bullish turn stems from his growing confidence in Netflix's ability to execute on its new initiatives. The introduction of an ad-supported tier late last year gives Netflix the ability to compete with a low-priced offering while also cashing in on the rebound of connected TV advertising. The rollout of paid sharing -- where family members and friends outside of an account holder's home using the same login information are being asked to create their own paid subscription -- gives Netflix a way to grow its sluggish user count if it can overcome the initial backlash.
The market saw through the superficially positive headlines in last week's Netflix update and sent the stock down. Boosting its free cash flow guidance from $3.5 billion to $5 billion for all of 2023 comes largely from the strike-related stoppage of new content production and the expenses will resume once Netflix starts paying for the fresh content it needs to remain engaging.
Netflix posted its strongest year-over-year growth in subscribers in more than a year, but average revenue per membership declined to the point where the top line for the quarter fell short of Netflix's own guidance. Despite boosting prices and its earlier claim that it was making up the $8.50 a month difference in tiers through ad revenue, top-line gains continue to be unimpressive at the streaming pioneer.
Image source: Getty Images.
Kesavabhotla still feels that the financial profile is improving at Netflix, and that last week's post-earnings retreat makes this a compelling entry point for investors. At least 10 analysts increased their price targets on Netflix last week following the report, and one of them went as high as $600 for their new short-term price goal. However, they all stuck to their previous market calls. They were simply bumping up their stock projections to keep pace with the buoyant shares since Netflix's previous financial update in April. Baird's move is an actual upgrade.
I agree with the sentiment behind buying the dip, but for different reasons. Profitless rivals are jacking up their price points in order to lose less money, and that gives Netflix a way to pad its market share as well as its margins. It also has a strong history of bouncing back from an initial quarterly fumble. The stock's a 20-bagger since its 2011 Qwikster fiasco, for example. There is nothing getting in the way of keeping Netflix as the leader of streaming services stocks. It won't always be a straight line up, and after roughly doubling over the past year a step back is understandable. But in the long run -- and despite its rich valuation -- Netflix should be able to hit $500 and beyond if it continues to execute with its core strengths as a business.
