This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Netflix's (NASDAQ: NFLX) stock surged 14% on Wednesday, Oct. 19, following Tuesday evening's release of its third-quarter earnings report. The streaming video giant's revenue rose 6% year-over-year to $7.93 billion, which beat analysts' expectations by $90 million. Its earnings per share declined 3% to $3.10, but still cleared the consensus forecast by $0.97.
More importantly, Netflix gained 2.42 million paid subscribers sequentially, which finally ended its two-quarter streak of subscriber losses. Do those positive developments indicate it's finally safe to buy Netflix's stock, which remains about 60% below its all-time high from last November?
Its revenue growth is still decelerating
Back in April, Netflix rattled investors with its first sequential loss of subscribers in over a decade. It mainly blamed that slowdown on tougher competition in the streaming space, the impact of the Russo-Ukrainian war, and users sharing their passwords. It said it would crack down on those shared passwords and roll out a cheaper ad-supported tier to attract new users, but those moves also suggested it was running out of ways to gain new subscribers.
During the third quarter, Netflix's number of paid subscribers grew again as hit shows like Stranger Things, Monster: The Jeffrey Dahmer Story, Extraordinary Attorney Woo, The Gray Man, and The Sandman drew in more viewers. It expects its number of paid subscribers to grow 2% sequentially (2.6% year-over-year) to 228 million in the fourth quarter.
| Metric | Q3 2022 | Q2 2022 | Q1 2022 | Q4 2021 | Q3 2021 |
|---|---|---|---|---|---|
| Paid Subscribers (Millions) | 223.1 | 220.7 | 221.6 | 221.8 | 213.6 |
| Growth (YOY) | 4.5% | 5.5% | 6.7% | 8.9% | 9.4% |
| Revenue (Billions) | $7.93 | $7.97 | $7.87 | $7.71 | $7.48 |
| Growth (YOY) | 5.9% | 8.6% | 9.8% | 16% | 16.3% |
Data source: Netflix. YOY = Year-over-year.
Netflix's stabilizing subscriber growth is encouraging, but its revenue growth continues to cool off. It attributes that slowdown to its growing dependence on international markets, which generate lower revenue per subscriber than its slower-growth U.S./Canada market, as well as the rising dollar's impact on its overseas revenue.
That's why it only expects revenues to rise less than 1% year-over-year -- and decline nearly 2% sequentially -- to $7.78 billion in the fourth quarter. However, that amounts to a 9% year-over-year increase under constant currency terms.
To stabilize its revenue growth, Netflix will start rolling out its cheaper "Basic with Ads" tier, which costs $6.99 per month in the U.S., on Nov. 3. That tier, which costs $1 less than Disney's (NYSE: DIS) ad-supported Disney+ and Hulu tiers, will stream videos at up to a 720p resolution and feature about five to five minutes of commercials each hour.
During the conference call, chief operating officer and chief product officer Greg Peters predicted the cheaper ad-supported tier would "bring in a lot more members" and become a "significant incremental revenue and profit stream" over the long term. However, Netflix's fourth-quarter revenue suggests those tailwinds won't really kick in by the end of the year. Those currency exchange headwinds are powerful.
Its margins are still shrinking
Netflix's operating margin of 19.3% in the third quarter beat its own forecast of 16%, but still contracted sequentially and year-over-year. It attributed most of its year-over-year decline to the appreciation of the U.S. dollar -- which will likely continue as interest rates continue to rise.
| Metric | Q3 2022 | Q2 2022 | Q1 2022 | Q4 2021 | Q3 2021 |
|---|---|---|---|---|---|
| Operating Margin | 19.3% | 19.8% | 25.1% | 8.2% | 23.5% |
| Free Cash Flow (Millions) | $472 | $13 | $802 | ($569) | ($106) |
| EPS Growth (YOY) | (3%) | 8% | (6%) | 12% | 83% |
Data source: Netflix.
It expects that pressure, along with the infrastructure investments related to its new ad-supported tier, to reduce its operating margin to just 4.2% in the fourth quarter. It also expects its earnings per share to plummet 73% year-over-year.
Netflix didn't provide an exact fourth-quarter estimate for its free cash flow (FCF), which fluctuates wildly based on its production of new content. But it expects to generate about $1 billion in FCF for the full year, which implies its FCF will likely turn negative again in the fourth quarter (since it already generated $1.3 billion of FCF in the first nine months).
Its valuations are debatable
Analysts expect Netflix's revenue to rise 7% this year as its earnings decline 10%. Next year, they expect revenue and earnings to grow 8% and 6%, respectively, assuming it continues to gain new subscribers and expand its ad-supported tier.
Based on those estimates, Netflix trades at 21 times forward earnings -- which is historically cheap but doesn't make it a bargain compared to traditional media companies. For example, Disney trades at 18 times forward earnings, while Paramount Global (NASDAQ: PARA) has an even lower forward price-to-earnings ratio of eleven.
At its current growth rates, I believe Netflix deserves to trade closer to its legacy media counterparts -- which also offer streaming video platforms -- instead of higher-growth tech companies. Therefore, I still don't think Netflix is a compelling buy after its latest earnings beat, especially as its revenue growth cools off and its operating margins continue to shrink.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
