Event: NFLX reports its Q3 earnings today after the close. The options market is implying about a 11.5% one day move, which is below both the 4 qtr avg of about 20.75% and the 8 qtr avg of about 22.5%.
Sentiment: Wall Street analysts are generally negative on the stock, with only 6 Buys, 23 Holds and 8 Sells, with an average 12 month price target of around $236. The stock’s short interest stands at 12.5% of float, which is its lowest level in the past 4 years:
That compares to a short interest of around 30% at this time last year.
Options Open Interest: Open interest actually favors puts to calls by a ratio of 1.1 to 1 despite a year-to-date gain of 260% for the stock. However, in the past month, calls have traded a bit more actively than puts, though not by much. The weekly 350 calls, the Nov 320 calls and the Jan14 320 calls all have around 2k of open interest.
Price Action / Technicals: NFLX is one of the best-performing stocks in the entire U.S. market in 2013. The stock is up 260% in 2013, and made a new all-time high (above $305) in September. The huge reversal of fortune in the stock is a sight to behold:
The previous all-time high from 2011 around $305 (in red) is the obvious level to watch on the downside, along with the $283 low from early October’s brief selloff. The stock hit a new all-time high on Friday, so no resistance on the upside.
Though the stock has shown momentum and volume divergences on the daily and weekly charts, the earnings event reaction will likely trump any lingering technical factors. The 11.5% implied move targets around $300 on the downside or $370 on the upside, though NFLX has rarely acted in line with the implied move in the past.
Fundamentals: 2011 was a tough year for NFLX. Its steady earnings growth rapidly reversed after a major loss of subscribers when the company essentially increased the price by splitting up the streaming and DVD rental services. In the meantime, the company has continued to lock in new content deals at a rapid pace, gathering the scrutiny of analysts who think those growing content liabilities will not be worth the cost in the future.
However, investors have been more optimistic, pleased with the rapid subscriber growth, which has led to consistent growth in revenues despite lower earnings. Consensus for this quarter is for 1.3 million domestic sub adds, and 0.9 million international sub adds.
Here is the progression of EPS vs. revenues since 2008:
| Adjusted EPS | Sales (Billions) | |
| 2008 | 1.44 | 1.36 |
| 2009 | 2.11 | 1.67 |
| 2010 | 3.27 | 2.16 |
| 2011 | 4.97 | 3.20 |
| 2012 | 1.01 | 3.61 |
| 2013 (expected) | 2.28 | 4.34 |
The company is expected to earn less in 2013 than it did in 2010, but revenues are more than twice as high. The hope among growth investors is that the company is able to leverage its strong sales growth and existing platform into rapid earnings growth in the future. Analysts expect around $6 in EPS in 2015.
Of course, the pivotal question with all such stocks is how to value them. We delved into some of the opportunities / risks for NFLX’s growth strategy in a detailed post in June. Microfundy’s takeaway (with which we agree) from that post:
I believe this is the reason that over the last few years $NFLX has probably been the single highest beta stock in the S&P500. The company is the epitome of leverage. It isn’t your typical financial leverage, and it isn’t even your typical operating leverage. But if subscribers grow as bulls think, and somehow their content costs stay stable or even decline – cash flow will flow straight to the bottom line, and you’ll have a cash cow. If however (which were the worries last year,) competition causes subscriber growth to stall, then the company is toast. Liabilities are just way too high to compensate.
Simply put, everyone’s focused on subscriber growth. That remains the key metric to watch, all other valuation metrics be damned.
Volatility: The implied volatility ahead of earnings for NFLX is much lower than it has been prior to the last 4 earnings releases:
That’s in large part due to the fact that NFLX realized volatility in the past 3 months has been much lower than at any point in the past year. Also, NFLX only moved 4.5% after its last earnings release, so traders are less willing to pay up for premium this time around. Implied volatility is likely to fall back into the high 30’s after the report.
Our View: NFLX is a very difficult stock to value by traditional metrics. That’s a big reason why it has been so volatile over the last 5 years, with two huge rallies, including over the last 12 months.
The stock’s momentum has attracted a trading community that could care less about fundamentals, for better or for worse. As a result, psychology has dominated the price action in the short-term, even as the company has made clear strides in the long-term. But trading NFLX is not for the feint of heart, especially with an earnings gap looming. Implied volatility is lower than it has normally been, but still quite expensive on an absolute basis.
We’ll post some leverage and protection ideas later today. We will likely stay out of the stock ourselves, though.