Source: Netflix.
Netflix (NFLX -0.88%) stock is clearly firing on all cylinders. Actually, this could even be an understatement: Netflix is up by a staggering 484% in the last five years, and it has risen 82% year to date.
Big gains are nice to have, but investment decisions need to be made in regards to future possibilities, not past performance. At this stage, investors may be wondering if it's time to take profits in Netflix, or if the stock still has any gas left in the tank.
Leading the streaming revolution
The online streaming revolution is alive and expanding at full speed, and Netflix is the undisputed leader in this industry. Netflix ended the first quarter of 2015 with a massive membership base of 62.27 million subscribers globally, gaining 4.88 million new members versus the same period in the prior year. In spite of its size, growth is not slowing down; on the contrary, the numbers show an acceleration versus 4 million additions in the same quarter last year.
Member engagement is at all-time highs, as viewers streamed 10 billion hours of content during the last quarter. Netflix is not only gaining new members at an amazing speed, but those members are also quite satisfied with the service.
According to data from BTIG Research, the average Netflix subscriber streams nearly two hours a day of movies and programs. This is a huge number, and it positions Netflix as not only the undisputed leader in online streaming, but also one of the main broadcast networks in the U.S. when considering both online and linear TV.
Offering a similar perspective, Sandvine calculates that Netflix accounts for a gargantuan 36.5% of all bandwidth consumed in the U.S during peak evening hours.
Netflix is no house of cards
Success attracts the competition, and it makes sense to expect growing competitive pressure from players such as Amazon (AMZN 2.05%) and Time Warner (TWX) over the years ahead. Time Warner's HBO has recently launched its HBO Now service, which is a considerable competitive threat because of the top-quality content HBO offers. However, Netflix is still competitively priced at only $8.99 monthly versus $14.99 per month for HBO Now.
Online TV alternatives are still much cheaper than linear pay TV options, and consumers can subscribe to multiple providers. Just like traditional TV has provided enough room for multiple players to grow and thrive over the decades, online TV should be big enough for Netflix and other competitors to continue expanding in the long term.
At the end of the day, it all comes down to competitive strengths, and Netflix looks quite healthy in that area. Massively successful original productions such as House of Cards and Orange Is the New Black are a big positive when it comes to differentiating the service from the competition, and they also yield solid returns from a financial point of view.
In the words of Chief Content Officer Ted Sarandos:
What we are seeing is the dollars invested in our original programming are more efficient, in that for every dollar spent, we get more bang for the buck in terms of hours viewed. And hours viewed leads to higher retention, more word-of-mouth and more brand halo. So that's why we say that it turned out to be not just an important strategic investment but also an efficient one.
Room for expanding profitability
Netflix's business model offers a lot of room for profit margin expansion. Assuming content costs don't change, each new subscriber is almost pure profit for the company, since the cost of streaming to one more subscriber is almost negligible. This has allowed Netflix to deliver growing profit margins in the U.S. over time, as revenue has outgrown content costs.
Contribution margin in the U.S. was 31.7% of revenue during the last quarter, substantially higher than the 25.2% reported in the same quarter last year. Management is planning to deliver margin increases of more than 200 basis points per year over the coming years, reaching a contribution margin of 40% in the U.S. by 2020.
Profit margins will remain under pressure in global markets, where Netflix is investing tons of money for growth. However, as these markets mature over time, margins should increase, too.
As Netflix adds more popular content to its library, the service becomes more valuable to each user, so the company is gaining pricing power, and higher prices could be another venue to increase profitability over the long term.
The way I see it, Netflix has the competitive strengths to continue consolidating its undisputed leadership position in online streaming. Besides, the business model provides plenty of opportunities to increase profitability over time. This means earnings have a lot of room for expansion, and that's the main reason I'm not selling Netflix stock anytime soon.
