Why Investors Should Avoid Netflix Stock - TheStreet

Why Investors Should Avoid Netflix Stock

This year is going to be one of the most challenging ever for Netflix.
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Netflix’s  (NFLX) - Get Report stock reaction to a largely positive report speaks volumes. The stock wavered between slight gains and slight losses after-hours, and this morning it's now down more than 2%. Why? Because the competition is growing from a noisy nuisance to an unavoidable fact.

Compounding the story, Netflix's revenue growth rates are guided for sub-30%, taken together with an overvalued stock, reminds investors to avoid this name. Here’s why:

Unavoidable Fact: Disney

Disney  (DIS) - Get Report launched Disney +, its direct to consumer platform, in the U.S. in November 2019 and right away it has started to dampen Netflix’s aggressive growth rates. 

Indeed, Netflix’s CFO Spencer Neumann himself noted on the call that Q1 2020 forecasts are baking in a full quarter of the competition compared with a partial quarter in Q4 2019.

Also, it should be noted that Disney+ is expected to reach Europe towards the back end of March 2020. How will this impact Netflix's global reach with consumers?  Many acknowledge that Disney will be a formidable force, the question for Netflix is just how formidable.

Thesis Demands Strong Revenue Growth Rate

Looking back to 2017-2018, we can see that Netflix's revenue growth rates were easily north of 30%.

Netflix Revenue Growth chart 012220

Now compare those numbers with how 2019 ended up, with its full year figure at a more humble 28%. 

Looking ahead to Q1 2020 and Netflix guides for 27% growth rates. However, this figure includes an aggressive price increase in the high single digits. How sustainable are Netflix’s price increases? 

Without competition, Netflix may have succeeded, even though cable providers have historically struggled to raise prices successfully. But now, with a plethora of competition, even Netflix’s enthusiasm for price increases is likely to be diminished.

Valuation -- No Margin of Safety

Going forward how does an investor possibly make the argument that Netflix is undervalued? Consider that, five years ago, Netflix was in effect the only streaming platform consumers considered a ‘must-have’. Today, the landscape is very different, with consumers having more options available than viewing time.

What's more, with a slowing growth rate, and already pricing in seven times trailing sales, does Netflix command any sort of realistic margin of safety? 

Moreover, investors have absolutely no idea what sort of potential free cash flow margins Netflix will succeed in having long-term. The next pressing question is of course: when does the company reach stability, when the huge amounts spent on content start bringing in strong free cash flow?

Given that for 2020 Netflix is forecasting approximately negative $2.5 billion in free cash flow, just $800 million less than its peak free cash flow burn, at this rate it would take until the latter part of the decade for Netflix to report positive $1 billion of free cash flow.

The Bottom Line

Netflix’s 2020 is going to be one of the most challenging for the company. 

The competition Netflix faces has never been more steadfast and poised to take market share. With an overvalued stock, declining growth rates, and overextended balance sheet, investors would do well to avoid this name.