Event: NFLX reports its Q4 earnings tomorrow night after the close. The options market is implying about a 10.5% one day move, which is below both the 4 qtr avg of about 20% and the 8 qtr avg of about 19%. However, the 2 quarter average move is only about 6.75%
Sentiment: Wall Street analysts are actually negative on the stock, with 7 Buys, 25 Holds and 8 Sells, with an average 12 month price target of around $352. The stock’s short interest stands at 10% of the float, which is actually its lowest level in more than 5 years. Here is the 5 year chart of total short interest:
Options Open Interest: Open interest is slightly skewed towards puts, by a ratio of 1.15 to 1. Recent activity has been evenly split, with calls and puts trading almost the same volume over the past month. The following strikes have over 1k of open interest:
-Weekly 300 puts
-Weekly 350 calls
-Feb22nd 250 puts
-Feb22nd 300 puts
-Feb22nd 315 puts
-Feb22nd 330 puts
-Feb22nd 350 calls
-Feb22nd 375 puts
-Mar 250 puts
-Jan15 125 puts
-Jan15 200 calls
-Jan15 250 calls
Price Action / Technicals: Dan wrote a Morning Word post on January 8th after NFLX stock convincingly broke its 50 day moving average on January 7th (Morgan Stanley downgrade was the catalyst), the first time it had cleanly broken the 50 day ma to the downside in the past 6 months. Since that break, the stock has struggled to find a bid even as tech stocks have broadly rallies. In fact, NFLX broke its 100 day ma last week for the first time since Nov 2012, when the stock was trading under $75:
The longer-term uptrend is still clearly intact (the 100 and 200 day ma’s are still rapidly rising), and the support area between $280 and $300 is massive. That area includes the rising 200 day moving average and the October spike low, and is also important because the 2011 high for the stock was around $305.
Interestingly, most of the price action since the last earnings announcement in late October has taken place within the intraday range of that post-earnings move (huge blue reversal candle above). That was the day when Carl Icahn sold his NFLX stake, and the stock has not been able to breach the $389 morning high ever since. That is the big resistance level on the upside. The 50 day ma around $353 is minor resistance.
Fundamentals/Valuation: We are quite optimistic on the secular trend towards more online video viewership (see our post on the future of online advertising from August). NFLX is very well positioned for that long-term trend. However, we tend to agree with the lukewarm view of many analysts, summed up on Friday by Goldman’s analyst:
We expect Netflix to report 2.2mn domestic subscriber additions in 4Q, towards the high end of guidance, on original content momentum, catch- up viewing of hit shows, and ongoing growth in the distribution ecosystem. We are forecasting GAAP EPS of $0.65, in line with consensus and towards the higher end of guidance for $0.47-$0.73, largely on improvements in international margins. While we continue to believe that Netflix is well positioned to benefit from the growth in digital media consumption and increasing economies of scale, at 28X 2014E EV/EBITDA vs. the sector median at 16X, we believe a high degree of success is already reflected in the stock.
The stock has seen some very recent weakness following a recent court decision on Net Neutrality:
Last week a federal appeals court struck down the Federal Communication Commission’s net neutrality rules, opening the doors for providers to charge companies such as Netflix (NFLX) fees for faster, more seamless streaming. Consumer advocates say those costs may be passed on to customers, and that the ruling may result in a tiered Internet whose providers can even block websites at will.
This obviously has long term implications for Netflix as they are probably Exhibit A of what could be the nightmare scenario for data intensive sites in a world where ISP’s with competing products and local near-monopolies can determine data speeds of sites streaming across their systems. This isn’t likely to play out right away but don’t be surprised to see those headlines of competing services from Big Cable put a little fear into the stock over the next months and year.
Domestic subscriber expectations are between 1.6mn and 2.4mn, with the consensus at 2.1mn. For international subs, the range is 0.9mn to 1.7mn, and a consensus of 1.4mn. Those will be crucial numbers to watch, as well as the overall guidance for the first half of 2014.
The overall valuation is still in the stratosphere, though that has not mattered for a long time since membership growth and user engagement has continued to grow so rapidly. However, elevated valuation does mean that any misstep is likely to be severely punished.
Volatility: Implied volatility for NFLX is much lower today ahead of earnings than for the prior 3 reports. A big reason for that is the low level of realized volatility since the October earnings release (as mentioned in the technicals section, the stock has been in a tight range ever since). The 1 year chart of 30 day implied vol:
Another low move on earnings (less than 10%), and implied vol in NFLX might even move sub-30 for the first time in many years following the event.
Expectations from Bloomberg:
Q4 Consensus:
4Q GAAP EPS est. 66c (range 56c-90c); NFLX forecast EPS 47c-73c in Oct.
4Q rev. $1.17b (range $1.16b-$1.20b)
4Q domestic streaming net adds est. 2.01m (avg of 6 ests.)
4Q intl streaming net adds est. 1.55m (avg of 6 ests.)
Q1 Consensus:
1Q14 GAAP EPS 75c (range 61c-91c)
1Q14 rev. $1.24b (range $1.20b-1.28b)
1Q domestic streaming net adds est. 1.8m (avg of 3 ests.)
1Q intl streaming net adds est. 1.275m (avg of 4 ests.)
Our View:
NFLX has lost its mojo ever since Carl Icahn exited the stock near the highs after the last earnings report. The company is a momentum darling, but under the surface we’ve seen some technical deterioration recently, and short interest is at a multi-year low.
Moreover, the fundamental situation continues to be controversial considering the company’s large ongoing liabilities in order to obtain favorable content. Dan discussed the increasing competition domestically in that same Morning Word post from earlier this month:
Bulls argue the next leg of the rally is going to come from international expansion. There are clearly risks, however. The company saw streaming subscribers surge last year on the success of their original content likeHouse of Cards and Orange is the New Black, but there are no guarantees that these programs will resonate in other locales as they have in the U.S. We remain just a tad skeptical, given the risk that content costs will at some point soon overwhelm profit growth and make the stock far less attractive.
With NFLX stock near the $300 support level, we’re not too interested in playing the short side ahead of the event, but we are still biased to the downside in the stock over the next 3-6 months. We might look at a rangebound play on earnings in the next couple days.