Things Are About to Get Ugly for Netflix

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It’s an admittedly overused cliche to say a particular earnings report is a make-or-break matter for a specific company. It’s even more cliche when the company in question is a battleground name like Netflix, Inc. (NASDAQ:NFLX). Yet — and to use another cliche — if the shoe fits …

For years, Netflix was given a pass on its frothy valuation, as the concept and growth potential was enough of a story to keep the stock edging higher. Over the course of the past year and a half, however, that’s changed.

The loss NFLX has suffered since late-2015 along with several downgrades of Netflix stock itself suggests pros and amateurs alike don’t believe the company will ever actually get to the promised land. This coming Monday, CEO Reed Hasting will have his chance to prove the growing number of doubters wrong. If he doesn’t, things could get ugly fast.

Netflix Earnings Preview

As of the latest look, analysts collectively expect the company to earn six cents per share on revenue of $2.28 billion when it reports fiscal third-quarter numbers after market close Monday. That’s a 31% improvement on the year-ago revenue tally, and would be typical of the company’s historic sales growth.

As for the bottom line, it’s projected slightly lower than the year-ago per-share profit of seven cents. This underscores the growing concern that the company is unable to control expenses and can’t muster growth without ever-increasing cash outlays.

Netflix had previously guided for the addition of 300,000 new U.S. members for the quarter, and FactSet says the analyst consensus is 310,000 new U.S. subscribers. Not all analysts are quite as optimistic. Baird analyst William Power expects U.S. numbers to be flat, echoing concerns voiced by M Science in late September.

Analysts Grow Pessimistic on NFLX

Were it just one or even two analysts increasingly expressing doubts about a fruitful future, it could be chalked up to “that’s just how things are.” It’s not just one or two analysts, though. It’s several of them, and they’re all saying the same thing. More than that, they’re putting their money where their mouth is, risking their reputations by downgrading Netflix stock.

The chart of how analysts’ opinions (and price targets) have changed over the course of the past two years tells the tale. Notice how rapidly the tide has turned in just the past few weeks.

The common element of their concerns, as Axiom analyst Victor Anthony put it in late August: “The competition is now real. It’s starting to impact subscriber growth.”

Macquarie analyst Tom Nollen downgraded NFLX stock last month, citing the following:

“Many countries Netflix is expanding into have been growing pay TV markets with incumbent operators that have invested in VOD/SVOD offerings, often as add-ons to existing subscriptions. In addition, numerous SVOD services have gotten off the ground, often at cheaper prices and offering more local content … U.S. growth could also be tougher in the near term, with more competition from, Inc. (NASDAQ:AMZN),which is doubling its content spending this year, and a plethora of OTT options coming to market, from HBO Now to skinny bundles to virtual MVPDs like Hulu Plus. These will all compete for producers ‘content and consumers’ time.”

And, most recently, Deutsche Bank had this to say: “This is a very long duration, high multiple investment with market expectations that appear too high through 2020, when most analysts seem to be looking for valuation support.”

In other words, the market is erroneously pricing Netflix stock as if the company will easily walk right into a “solidly profitable” status CEO Reed Hastings has recently alluded to.

It won’t be easy, or quick, if it happens that way at all.

Bottom Line for Netflix Stock

Netflix has never been a wildly profitable company, so even if that doesn’t change, the market isn’t likely to punish it. The key here is subscriber growth (or lack thereof), particularly in the U.S. It had always been healthy, but beginning last quarter — when competition surfaced in earnest — it slowed to a crawl.

It’s a problem for Netflix stock, as NFLX shares are largely valued on the assumption that rapid growth would justify the lack of profits. If it can’t muster growth or drive respectable income, the bullish thesis could unravel in a hurry.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.