(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his client’s own shares of NFLX.)
Reed Hastings, the CEO of Netflix Inc. (NFLX), has set a high bar for the company when it reports fourth quarter results on Thursday after the close of trading. That's because the company set extremely lofty expectations with its forecast for fourth quarter subscriber growth, the most critical metric investors follow for the company. Couple that with the latest news that Netflix plans to raise its prices by as much as 18% for its U.S. subscriber base, its highest ever. That will enable the company to maintain its aggressive spending on streaming film and TV content to attract even more subscribers.
Investors don't seem to mind that Netflix earnings are expected to fall in the fourth quarter as it spends to fuel growth while the U.S. and global economy slow. The stock has surged by more than 25% this year.
CEO Hastings is expected to deliver once again when results are announced. The guidance the company issued called for net additions of 9.4 million subscribers in the fourth quarter. That would be 13% higher than the 8.3 million the company added in the fourth quarter of last year, and 35% more than the company reported last quarter. Netflix said it expected net international additions of 7.6 million and 1.8 million in the U.S.
International is The Growth Driver
The international subscriber base of 78.6 million has long passed the domestic base of 58.5 million. However, it was only in the second quarter of 2018 that international revenue exceeded domestic revenue. During that quarter, international revenue increased to roughly $1.92 billion versus domestic revenue of $1.89 billion.
While investors debate just how quickly Netflix's subscriber base can continue to grow, it's clear that India is likely to be a big market. Hastings believes Netflix's subscriber base can climb to as high as 100 million in India, which is about 80 percent higher than its current U.S. base of 58 million.
Netflix faces challenges in its effort to boost international revenue. For example, the company generated average revenue per user of roughly $8.36 in its international segment versus $11.04 in its domestic segment in the third quarter. However, international revenue may be on the rise because the company has no plans to cut its prices in places like India. Netflix currently charges between $6.90 to $11 per month in India, which is slightly cheaper than what Netflix charges in the U.S.
Strong Revenue Growth In the Fourth Quarter
Netflix's priority is financing growth, which has squeezed profit margins. That's one reason why analysts are forecasting earnings will fall 42% even as revenue grows 28% in the fourth quarter. Investors also will be paying close attention to the company’s ballooning debt, which was over $8 billion in the third quarter and a topic of concern in some quarters.
Investors Are Bullish
The high expectations for Netflix may be why the options market is expecting a great deal of volatility following the results. The long straddle options strategy for expiration on February 15 suggests the stock rises or falls by nearly 13% from the $350 strike price in morning trading on January 15. It places the stock in a massive trading range between $304 and $395 by expiration.
The technical chart is also bullish, pointing to the stock’s continued rise in the coming weeks. The shares are currently breaking out and rising above a longterm downtrend. It would suggest the stock could increase 10% further. The relative strength index appears to be breaking out as well, suggesting bullish momentum is entering the stock.
Netflix has an enviable problem that goes with its success. The higher the stock rises before results, the more difficult it will be for the company to exceed expectations. Given how jittery tech investors are today, the stock would probably pull back if Netflix missed estimates for subscribers or revenue - either in the fourth quarter or in its guidance. It makes the current results extremely important because the company took a significant risk with such optimistic subscriber guidance. This puts a tremendous amount of pressure on the company and may have a significant impact on the stock in 2019.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.