Netflix (NFLX) - Get Report has soared more than 40% in the past few weeks. Investors are hoping that the company will prove that despite a global recession as well as the arrival of strong competition that Netflix will still able to guide for approximately 30% revenue growth rates and maintain strong subscriber growth numbers for the quarter ahead. With sky-high expectations and a nosebleed valuation, however, investors would do well to avoid this stock for now. Here's why:
Q1 2020 Results: What To Look For
Netflix's guidance details will have significant implications. Here, there are two separate and contrasting dynamics at play. On the one hand, there are huge expectations factored into Netflix’s share price, with its shares soaring 40% since the lows set in March, based on the thesis that Netflix will be a huge beneficiary from the current stay-at-home environment.
On the other hand, there are two meaningful risk factors at play: Netflix's ability to raise prices during a global recession and its first full quarter with Disney on the scene.
Breaking Down Netflix’s Revenues
Netflix generates approximately 45% of its total revenues from the U.S. Recently, Netflix’s domestic growth has been predominantly driven by price increases rather than through significant increases in paid memberships. Specifically, Netflix has succeeded in raising its prices by roughly 17% compared with the same period a year ago in Q4 2018, whereas its paid net additions trended down throughout 2019.
On the other hand, Netflix’s has had no trouble increasing its numbers of paid subscribers internationally. However, Netflix’s ability to raise prices internationally has been mixed, with unimpressive price increases in Europe, Middle East and Africa and Asia Pacific, offset by solid price increases in Latin America of 18% excluding FX.
It could be said then that Netflix’s bullish thesis is now contingent on Netflix’s ability to benefit from consumers' increased time at home, with the expectations that this will increase its number of paid members to its platform, and that these members will remain on the platform once life starts to returns to normal.
Competition Has Arrived
Disney+ arrived on the scene in November 2019, meaning Netflix’s Q4 2019 results were only partially impacted Disney's offering. However, Disney’s latest figures show that Disney+ already has 50 million global subscribers, with some analysts suggesting that Disney+ is likely to reach approximately 70 million global subscribers by late June. In this event, Disney+ would reach close to 40% of Netflix’s global paid members just eight months after its launch.
Consequently, with more competition than ever before, together with a global recession on the horizon, this raises the question: can Netflix continue succeed in growing its revenues through price increases? Or will it struggle more than its valuation currently prices in?
Valuation - No Margin of Safety
Going into its Q1 2020 results, investors are clamoring for Netflix’s stock and bidding up its shares by slightly more than 9.5x its trailing sales. This is the highest multiple of sales Netflix has carried over the past decade. In other words, investors' expectations have never been higher for this free cash flow burning company.
Despite my bearishness, it should be noted that in the event that Netflix guides for its next quarter, ending in June, for Netflix's revenue growth rates to grow by 30% compared with the same period a year ago, investors would be very forgiving of any potential investment concerns on the horizon.
The Bottom Line
Investors are enthusiastically pricing Netflix at 9.5x trailing sales, implying that they are hoping for significant positive surprises to come out of its guidance on Tuesday. The bulls believe that Netflix will be a huge beneficiary of our current stay-at-home environment. But the bears, like myself, believe that sky-high valuations, a global recession and increased competition will take a toll on Netflix's near-term prospects.