A Deep Dive into the Fundamentals for Netflix

25 Aug 2021

By Eric Lee, Account Manager, Phillip Futures

Source: Phillip MT5

Since the start of the global vaccination drive in December 2020, Netflix’s share price has been trading uneventfully within the range of $500-$600. After the consolidation, Netflix looks set to offer an opportunity to buy into this market leader for its next leg of upward movement.

On a short-term basis, we see a number of support points, including the 250-day Moving Average, Symmetrical Triangle consolidation formation and the Stochastic turning up from oversold region. Short-term support at US$500, followed by $475. Resistance at US$560. Traders looking for entry signal can either:

  1. Buy when price breaks above resistance of US$560, or
  2. Buy nearer to the Symmetrical Triangle support of US$490-$500 region

For long-term investors, please read on to learn more about Netflix’s performance so far and about my view on the growth engine of Netflix and its financial analysis.

Performance so far:

Since its transformation from a DVD rental business to being the first mover in the streaming industry, Netflix’s performance has been nothing short of spectacular. Since 2016, it grew its revenue by almost 30% p.a. and grew its Earnings Per Share (EPS) by a whopping 97% p.a. Its Return on Equity (ROE) and Operating Margin had also improved during the same period at the same rate of growth as its revenue.

Even though Netflix’s business is still growing, the market is worried about the stiff competition that Netflix is now facing in the form of Disney+, Amazon Prime an Apple TV. These concerns are not unwarranted, especially as some of these competitors, such as Disney+, has a strong portfolio of content, which could pose some serious threat to Netflix.

My personal view is that the total addressable market for streaming is big enough for Netflix to grow together with the others. For Netflix, these are the five key growth engines that can propel its business forward for many years to come.

Growth engines:

Pricing Power

Netflix’s ability to increase market share with more new subscribers added, with low churn ratio and still able to increase its Average Revenue per Membership, across all regions that it is operating in. This is achieved not by squeezing more out of its customers but by providing greater value such that they do not mind paying a little bit more for it.

Source: Q2 2021 Netflix Shareholders letter

Large Total Addressable Market (TAM)

According to Nielson study’s estimate, Netflix only represented 7% of the entire US TV screen time. Even the entire streaming market combined, only takes up 27% of the US TV screen time. Thus, we are only witnessing the early days of the transition from linear to on-demand consumption of entertainment. If this is the huge TAM available in a mature market such as U.S., we can only imagine the global penetration rate.

Expansion into the Developing Market

To expand its reach to developing economies in Asia and Africa, which primarily uses mobile phones as their mode of entertainment, rather than TV and PC, Netflix worked with local Telcos to launch mobile-only subscription plan from as low as $2.60 (in India). (Reference)

Improving Operating Margin

Despite its aggressive expansion, Netflix’s finances are at a stage where they are cash flow positive and likely do not need to rely on external sources to fund its operations. Operating Margin has been improving consistently over the past 5 years and the management is committed to keep improving it by a target rate of 3% per year.

Optionality

Netflix’s mission statement is that they “want to entertain the world”. Thus, they are not just a streaming company, or just a movie or TV content producers. They are looking beyond current suite of products and looking to let its customers play video games on its platform as it headhunted former Oculus and EA game development leader, Mike Verdu, to lead its new gaming division. This is a possible game changer. In a recent interview, Netflix mentioned that it intends to add the gaming feature at no additional cost to his subscribers. Unlike most mobile games that require gamers to pay more to level up or open loot boxes, Netflix’s subscription model will free its game developer from this shackle, allowing them to focus on bringing the best content to gamers without having to think of how they can continually milk its users.

What does it all mean for Netflix going forward?

Over the last 5 years, Netflix grew its Net Operating Profit After-Tax (NOPAT) by $5.2b. During the same period, their total capital invested had increased by $10.8b. Thus, these additional retained earnings had generated return of 48%. Since Netflix reinvested about 85% of their profit generated over the same period back to the business, we can calculate Netflix’s growth rate over its retained earnings from 2016 to 2021 as (85% x 48% =) 41%.

The annualised return of Netflix’s share price, for the same period of July 2016 to June 2021, is 42.15%. This figure is almost similar to the growth rate derived from its return on its retained earnings.

Though past result is not a guarantee for future performance, a top performer likely remains a top performer, or at least in the near future. Yet, we can’t ignore the stiffening competition in the streaming industry, which can affect Netflix’s profit margin and growth rate going forward.

It is quite tough for Netflix to continue at this annualised growth rate of 40% p.a. but on the assumption that its management continue to execute their business well, its growth rate should continue normalise and achieving annualised growth of 20% over the next 5 years should still be a possibility for Netflix.

Disclaimer

Please do your own due diligence on the company’s fundamentals & assess if the Fundamental & Technical analysis opinions are applicable to your trading or investing needs. Click here to view our disclaimer.


Eric Lee is an Account Manager with Phillip Futures. With expertise in Futures, Forex, Stocks, and Unit Trust, Eric makes an all-rounded advisor. Make informed trading decisions without spending time combing through endless information as Eric readily provides clients with trade alerts and insights via WhatsApp. Over his years of experience, Eric developed systematic strategies in trading and investing. Book a complimentary coaching session below to leverage on his expertise as he imparts his knowledge to enhance your trading journey.

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