Netflix Up 60%, Stock Overvalued say Analysts

Morningstar equity analysts Netflix has a small sustainable competitive advantage over peers, but the share price is significantly overvalued

Morningstar Equity Analysts 17 April, 2018 | 11:11AM
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Netflix has reached 125 million subscribers

Netflix (NFLX) started 2018 with strong subscriber growth as the firm beat its guidance once again – hitting 125 million subscribers. The stock is up 60% since the start of the year from $192 to $308.

Despite the increased number of subscribers, Morningstar equity analysts believe the stock only has a small sustainable competitive advantage – expressed as a narrow moat rating. Analysts set the fair value estimate at $90, meaning the stock is significantly overvalued. We project that the firm faces increased competition over the next five years, necessitating an ongoing cash burn and limiting the rate of margin expansion.

While segment contribution came in above our projections, the firm pushed out its content and marketing spend into the second half of the year. As a result, the free cash flow loss for the quarter was only $287 million, an improvement sequentially from the loss of $524 million in the fourth quarter.

However, management continues to project free cash flow burn of $3 billion to $4 billion for 2018, up sharply from $2 billion loss in 2017

Netflix reported better-than-expected subscriber growth in both the international and U.S. segments. Management persists in attributing its net add outperformance to excitement around original content and the continued adoption of streaming video.

Netflix continues to expand its streaming base, ending the quarter with more than 118.9 million global paid subscribers, up from 94.36 million a year ago. Revenue of $3.7 billion came in just ahead of our $3.59 billion estimate with the majority of the beat coming from domestic streaming.

Domestic streaming monthly revenue per paid member came in at $11.25, up 12% year over year and ahead of our $10.85 estimate. For international streaming, revenue of $1.78 billion was slightly above our $1.74 billion estimate as monthly revenue per paid member came in at $9.77, up 21% year over year.

While the segment contribution margin of 27.7% outperformed our projection by 363 basis points, operating margin of 12.1% came in tighter than our 10.5% expectation. The firm continues to ramp its R&D and G&A spend, limiting leverage of these categories. Part of the increased spend for the firm is build out of its own studio. While Netflix is well known for its original content, most of the content was produced by an outside studio such as Lionsgate, including smash hit Orange is the New Black, and Netflix acted primarily as the financier and distributor.

With the addition of a physical studio, Netflix could avoid some of the issues around production scheduling as well as attract talent who want to remain in LA. The firm also continues to spend on technology development, particularly on the mobile side. While the mobile opportunity could be large in a market such as India, we believe that the firm’s premium pricing will limit the uptake, particularly if competitors such as Amazon and Fox’s Hotstar continue to undercut Netflix on price.

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Morningstar Equity Analysts  Morningstar stock and fund analysts cover 2,000 mutual funds, 2,100 equities, and 300 exchange-traded funds.