Netflix (NASDAQ: NFLX) is one of the strongest virus stock , which soared to its all-time high in the height of the stay-at-home pandemic. However, its latest Q1 2020 earnings cast doubt if this is the peak of stock? Is this the right time for investors to sell Netflix stocks and claim profits.
Netflix is an ad-free, on-demand video streaming service that earns money from paid subscriptions. Hence, its stock is directly proportional to the change in subscribers.
Amidst the global lockdown, Netflix recorded its highest-paid membership of ~183 million; ~16 million new subscribers joined in Q1 2020. The stock’s rally to its all-time high of $449.5 shows that investors had already priced in the 100% increase in subscriber base.
As the global lockdown eases and life returns to normal, Netflix will see a slowdown in new subscribers. It is difficult to put the post-pandemic impact in numbers, but the company’s best guesstimate is the addition of 7.5 billion subscribers in Q2 2020.
Last time the company reported a slowdown in subscriber additions was in Q2 2019 when the stock fell 10%. This time, Netflix stock declined 2.86% on Apr. 22 as investors assess the company’s downside risks from the pandemic.
Being an entertainment company, Netflix’s biggest asset and expense is content. It spends millions on developing original content and acquiring existing content to attract more subscribers and encourage them to stay subscribed. When Netflix will start losing its pandemic-driven subscribers, it’s the biggest arsenal to retain them would be its new original content.
Entertainment juggernauts like Disney Plus, NBC Universal’s Peacock, and WarnerMedia’s HBO Max do are out of original content as media production halts amidst the lockdown. However, Netflix has plenty of new original content coming in 2020 thanks to its binge-watching model in which it releases a complete season in one go, stated Theodore Sarandos, the chief content officer of Netflix. The pandemic-driven lockdown will slow Netflix’s 2021 releases.
Producing original content has put Netflix in a $14 billion debt, more than double its $6.5 billion cash. Also, the company is raising $1 billion in debt to use as working capital or fund acquisition and development of content.
During the lockdown, Netflix’s cash outflow fell as new content production stalled worldwide, except in South Korea and Iceland. On the other hand, its new subscriptions boosted cash inflows. For the first time in five years, Netflix reported a positive operating cash flow of $260 million in Q1 2020. However, the company may not be able to maintain the pandemic-driven positive cash flow for long.
Moody’s and S&P rating agencies have rated Netflix’s credit close to “junk,” which means it is at a higher risk of default. In these challenging times, all companies are preserving cash to prepare for the resulting economic downturn. It is not clear how Netflix’s junk bonds will impact its business operations in a recession.
The first rule of the stock market is to buy cheap sell expensive. Netflix stock is currently trading at 8x its revenue per share and 80x its earnings per share. This valuation shows that investors have already priced in significant earnings growth. As the company expects its growth to slow in the second half of the year, investors will price in the post-pandemic risk and correct the valuation. The stock could see a significant selling activity.