Netflix: Are Rising Rates Enough To Take The Wind Out Of its Upward Momentum?
The biggest financial news story of 2021 continues to be the rising interest rates attached to U.S. treasury notes. We’ve been in a bull market, in the bond space, for roughly 40 years now. In recent decades, we’ve seen periods of time when interest rates rose temporarily, but in general, the trend since the early 1980’s, the trend is decidedly lower. What this means is that very few investors have any experience picking stocks and managing portfolios during a sustained bear market in the bond space. This lack of experience leads to uncertainty, uncertainty leads to fear, and in the stock market, fear is the catalyst which moves share prices lower.
Throughout 2021, we’ve seen the board market indexes move higher, in spite of the perceived headwind that rising rates represents. At 32,627, the Dow Jones Industrial average is sitting just off of its all-time high of 32,858. At 3,913, the S&P 500 is just off of its all-time high of 3,930 as well. The S&P 500 is the well diversified average that many investors use to benchmark their portfolios against and this index is up 4.17% year-to-date. On an annualized basis, this points towards double digit total returns, which would represent an above average year for the broad market. With this being said, it’s clear that the uncertainty created by rising rates has not yet permeated the entire market; however, it has crept into the calculus of investors in the high growth space.
The NASDAQ 100 index is down 0.19%, year-to-date, meaning that it has underperformed the S&P 500 by roughly 440 bps. And, some of the popular big-tech names from within the NASDAQ index are down much lower. Netflix (NFLX), which was the top performing large-cap stock in the entire market during the prior decade, producing total returns of greater than 4,000% during the 2010’s, is one of the recent underperformers.
NFLX shares are down 5.28% year-to-date. Barani Krishnan, a 5-star Nobias analyst who writes for Fintech Zoom, recently published a piece which spoke about the divergence between the major market indexes and high flying growth stocks, such as Netflix, says: “Yields spiked after an unexpected slump in U.S. jobless claims to November lows triggered fears of faster inflation, spooking investors into reining in bullish bets on stocks. Nasdaq was the favorite target of sellers as it had run way ahead of the Dow and , which looked more valuable compared to the grossly-inflated price-earnings ratios of stocks on the tech index, which included the likes of Facebook (FB) , Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and Google (GOOGL).”
In a rising rate environment, it makes sense for investors to reevaluate equities, on a risk-adjusted basis, due to the more stable and reliable returns that fixed income investors generate. Netflix appears to be a prime candidate for a re-rating, due to its very high, 74.4x blended price-to-earnings ratio (for comparison’s sake, the S&P 500’s forward price-to-earnings ratio is roughly 22x at the present time).
However, what bond holdings can not offer is growth when it comes to the underlying fundamentals that a company creates, which is why investors are often drawn to the higher risk/reward scenario attached to risk assets like equities. And, when it comes to growth, there are few large cap names that do it better than Netflix, which produced earnings-per-share growth of 47% in 2020. Right now, the consensus analyst estimate for NFLX’s 2021 earnings growth rate is even higher, at 62%.
As Kristnan points out, we’ve witnessed a stark re-adjustment with regard to the premiums placed on big-tech stocks. However, with specific regard to Netflix, we have noticed that professional analysts are still attracted to the company’s growth story and have, for the most part, continued to raise their price targets throughout 2021.
Aneta Larkins, another 5-star Nobias analyst writing for Fintech Zoom, recently highlighted a slew of analyst updates pertaining to NFLX shares. In her piece, she noted one downgrade, coming from analyst firm, Benchmark, which recently lowered its price target on NFLX shares from $485 to $472. The firm issued a sell rating to its clients, due to the fact that at $512, NFLX’s share price is roughly 7.7% higher today than its new price target.
However, Benchmark’s negative outlook is fairly unique, with other major analyst/analyst firms coming out with bullish ratings and rising price targets. Larkins reports that Morgan Stanley “upped their price objective on Netflix from $650.00 to $700.00 and gave the stock an “overweight” rating in a report on Wednesday, January 20th.”
She also notes that Barclays came in with an “overweight” rating of NFLX shares, with a $650 price target, UBS Group moved NFLX from “neutral” to “buy” with a $650 price target, and Piper Sandler increased its price target from $643 to $652. Overall, Larkin says, “Four analysts have rated the stock with a sell rating, eight have issued a hold rating and twenty-five have given a buy rating to the company’s stock. She continues, saying, “Netflix currently has a consensus rating of “Buy” and a consensus price target of $580.62.”
Danny Vena, of The Motley Fool, shares this consensus bullish outlook, recently highlighting three reasons to buy NFLX shares. In Vena’s article, he highlights the company’s recently announced decision to crack down on password sharing as a major catalyst for revenue growth. NFLX has recently began testing measures which ensure that users are not sharing subscription passwords without close family members or those who live outside of their household.
Vena notes that “data suggests that as many as 33% of users share their Netflix password.” He continues, saying, “With 204 million subscribers, that could amount to at least 67 million unpaid viewers. Given the $14 monthly charge for Netflix's most popular tier, the company is potentially forgoing more than $11 billion in revenue each year.”
Vena also believes that Netflix could take a page out of the legacy media playbook and license select content to peers as a way to increase high margin cash flows. He said, “Netflix is considering licensing some of its older movies and television shows, and has had discussions with Comcast's (CMCSA) Peacock and ViacomCBS (VIAC), among others.” In his view, this lack of exclusivity could actually result in higher demand for its subscription service as a wider audience gets a taste of its original content and realizes what they’re missing out on.
And finally, Vena highlights NFLX’s potential to launch lower priced subscriptions, which could also drive incremental revenue for the company, especially in emerging markets, where the company’s current subscription cost can be prohibitive.
Anusuya Lahiri, a 5-star analyst who writes for Bezinga, also recently touched upon Netflix’s mobile only plans which it promotes throughout Southeast Asia, which come in at only $5/user as opposed to the $14/user subscription cost that is attached to the standard service. She notes that NFLX has only 25 million paid subscribers in the Asia-Pacific region, meaning that further penetration into these densely populated markets could represent a major growth story for the company in the near-term. Lahiri highlights recent plans that Netflix announced regarding capital spending on content meant specifically for these markets.
Lahiri notes that Netflix has spent $400 million on the Indian market already and she touches upon the company’s plans to spend $500 million on film and series production for South Korean markets. This comes on the heels of $700 million worth of prior investments into the South Korean entertainment industry.
However, all of this capex could prove to be well worth the risk due to the overall population, internet penetration, and disposable income growth that is expected to occur in this region of the world. Lahiri says, “Southeast Asia’s internet economy can be worth $300 billion by 2025 from the growing popularity of video streaming and music subscription services.”
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
With regard to content related capex, Luke Lango, another 5-star Nobias analyst who writes for Investor Place, recently penned a piece which highlights the “virtuous growth cycle that will keep firing on all cylinders for the foreseeable future.” To summarize Lango, Netflix invests heavily on content, which leads to high quality and intriguing content that catches the public’s eye.
Then, due to the high quality nature and general popularity of this content, NFLX originals tend to win “a bunch of awards” which creates buzz on in the news and on social media. This buzz leads to new subs, which fall in love with the content as well. This demand leads to pricing power, allowing the company to increase its subscription price “without much churn.”
Lango continues, saying that “more subs plus higher prices equals bigger revenues, bigger margins, and bigger profits.” “It also equals more data,” he adds. These bigger profits allow the company to invest into and create even more high quality content, which refreshes the cycle all over again.
Lango is an admitted bull, and his argument ignores rising competition in the streaming space. This “virtuous cycle” was able to exist in a vacuum for several years due to Netflix’s first mover advantage in the digital streaming space. However, over the last year, we’ve seen a handful of high powered competitors launch streaming services, such as the aforementioned Peacock and ViacCBS services, as well as Disney’s (DIS) Disney+ service, which has stormed onto the scene with 95 million subscribers is roughly a year’s time.
It’s unclear as to whether or not Netflix will enjoy the pricing power that makes this cycle work into the future now that there are cheaper priced services (Disney+, for instance, only costs $6.99/month, approximately half of Netflix’s standard price). However, Lango cites Netflix’s recent performance at the Golden Globes as reason to believe that the company is still the top dog in the media space. Netflix had the most nominations (42) and the most winners (10) of any media/entertainment company.
Lango believes that content is king in the media space and concludes, “as goes Netflix’s content, so goes NFLX stock.” If Lango is right, with the Golden Globe trophies in hand, it appears that NFLX shares are bound to break out of its recent slump and head higher, towards that analyst consensus price target of $580/share.
Disclosure: Nicholas Ward has no position in Netflix. He is long DIS and CMCSA. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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