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September 01, 2020 1:32pm
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Buy the Dip in Netflix Stock, It Won’t Last Long

Netflix Stock price

Netflix (NASDAQ: NFLX) shares fell 5% following the Q1 release and guidance update, opening up a buying opportunity that will not last long. The sell-off is a knee-jerk reaction to reporting changes that have little bearing on the business outlook. Netflix says it will stop reporting subscriber numbers next year because the business has evolved, and the figures are less important than before. Instead, it focuses on revenue growth, margin expansion, cash flow, free cash flow, and capital returns, which are far more important.

Subscriber growth was one thing when the company wasn’t making money; now that it is a mature, blue-chip tech stock making money, it’s time to focus on that. 

Netflix has a Robust Quarter and Raises Guidance

Netflix had a solid quarter, producing $9.37 billion in revenue. The top line is up 14.8% due to the combined impact of increased subscriber count and higher prices. Global streaming paid membership grew by 3.5% sequentially and 16% YOY, offset by weakness in ARM. USCAN led with a 7% increase in ARM, while all other segments were flat to down. 

Margin news is the brightest spot in the report. The company is gaining leverage via increasing member count and higher prices and driving solid improvements on the bottom line. The company reported a 700 basis point increase in the operating margin aided by the timing of payments and content spending. Even so, the 28.1% margin is among the highest on record and outpaces the ten-year average by 1200 basis points, and strength is expected to persist into the future. 

Guidance is solid, but there is a caveat. The company raised the target for revenue and earnings, but the news is mixed relative to the consensus reported by Marketbeat. The silver lining is that margin strength and above-target earnings offset weaker-than-expected revenue. The company raised its full-year operating margin target by 100 basis points to 25% and Q2 EPS forecast to $4.68 compared to the $4.55 consensus. 


Analysts Lead Netflix Market Higher

The analysts' activity is mixed following the report, but the net result is bullish for the market. Marketbeat tracks one downgrade to Hold and one reduced price target, but more upgrades and price target increases offset them. The consensus remains firm at Moderate Buy, edging to Strong Buy with a price target near $630. The $630 price target implies about 3.5% upside for the market and is up 10% in the last 30 days. Because many of the new targets are at the range’s high end, this market could move up to retest the all-time highs soon. 

Capital returns will help support the market. Netflix doesn’t pay dividends but uses excess capital to repurchase shares. Excess capital is free cash flow after business investment and balance sheet maintenance, which aims to maintain a credit-quality rating. 

The company announced changes to its financial strategy, including increasing its revolving credit facility to enhance liquidity and improve cash flow efficiency. The company specifically stated it has no plans to lever up to sustain repurchases. Repurchases were substantial in 2023 and Q1 2024, reducing the average fully diluted count by 2.6%. Moody's rates NFLX credit at Baa2 with a positive outlook. 

Netflix Falls to Critical Support

There are many reasons to believe NFLX stock will rebound quickly, but that doesn’t mean it will. The market is down 5% following the Q1 news and could break critical support. If the market does not support the stock price at $575, there is a risk that it will fall into a trading range in which it will be stuck. The company is in fine shape and growing, but the 35X earnings valuation is high. If the market supports this stock at $575, a rebound should begin soon. Even so, in this scenario, there is a risk of range-bound trading only at higher levels. The critical resistance is near $640 and may be strong. 

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