Event: NFLX reports its Q2 earnings today after the close. The options market is implying about a 8% one day move, which is below both the 4 qtr avg of about 9.25% and the 8 qtr avg of about 17.5%.
Sentiment: Wall Street analysts are fairly neutral on the stock with 18 Buys, 18 Holds and 7 Sells, with an average 12 month price target of around $431, despite the 21% return for the stock year-to-date, as well as the huge run over the past 2 years. The stock’s short interest is now around 9% of the float, close to the level where it began the year, though much lower than where it was 2 years ago:
Options Open Interest: Total open interest is slightly skewed towards puts over calls by a ratio of 1.1 to 1. One month average volumes have been evenly split between puts and calls. Of near-term strikes, the Jul25th 475 calls and the Aug16th 370 puts are the only strikes with over 1k of open interest. Farther out, the 400 and 500 strikes are the most important, as the Sept and Jan15 500 calls, the Sept 400 puts, and the Jan16 400 calls all have over 1k of open interest.
Price Action / Technicals: NFLX recently broke out to a new all-time high in early July. However, the stock’s selloff back below the March high of $458 has broken the momentum of the uptrend:[caption id="attachment_43148" align="alignnone" width="600"] NFLX daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]
The $458 level marked in red is crucial. A clean break back above there, and no resistance remains on the upside in NFLX. Failure to regain that level leads to a chart that has the markings of a false breakout. On the downside, the $400 level is important psychological support, and the rising 200 day ma is now around $379.
On the longer-term chart, we can see the pivotal nature of the $300 level, which held as long-term support on the selling in mid-April:[caption id="attachment_43149" align="alignnone" width="600"] NFLX weekly chart, Courtesy of Bloomberg[/caption]
Fundamentals/Valuation: We have traded NFLX twice so far in 2014, with one winner and one loser. The volatility in the stock in the past 6 months has been amazing, as NFLX rallied from near $300 to $458, sold off back to near $300, and then rallied back to around $450 today.
Clearly, the price action in the stock has been much more volatile than the underlying business itself. NFLX delivered a strong Q1 report, and EPS is expected to double in 2014, and increase 50-75% in 2015 and 2016. However, NFLX still trades at a 45x P/E on the 2016 consensus expected EPS of around $10.
At that valuation, the concerns for the stock become amplified at each misstep. While the company has done incredibly well with its first mover advantage in streaming online video, we remain skeptical about its ability to maintain its market share and growth in the face of increasing competition. Here were our thoughts from the early May trade post:
First, the company is running into increased competition on multiple fronts (AMZN / HBO deal, recent AT&T / Chernin group deal). NFLX has first mover advantage, but its huge content costs leave it quite vulnerable.
Which brings us to the second, and more crucial point. NFLX’s recent deal with Comcast was a sign of capitulation in our view. Comcast won, and NFLX lost, plain and simple. Netflix is Netscape, they just doesn’t know it yet.
Between the net neutrality rulings and everyone moving into their market, NFLX will probably go down in history as a first mover that eventually got overtaken by the big boys it once threatened.
Comcast (and others) control the operating system on our televisions just as Microsoft did on our PCs in the 90′s. What that means is the big boys can wait for threats to their business models like Netflix represents to Comcast (the threat is cord cutters) and then give away a clone of that threat on their own system for next to nothing or free until the threat is gone.
NFLX is furiously working on its original content as well as international expansion to diversify the business and offset some of these competitive threats. But with the big guns fast on Netflix’s heels, we don’t like the company’s odds in the long run.
Of course, the short run is a different story, and that’s why we don’t plan on a new trade in the stock ahead of earnings this quarter.
Volatility: Traders have ratcheted down expectations of a big move for NFLX on this quarter’s earnings event, reflected in lower-than-usual 30 day implied volatility ahead of earnings:[caption id="attachment_43150" align="alignnone" width="600"] 30 day implied volatility in NFLX, Courtesy of Bloomberg[/caption]
The implied move of 8% is below both the 4 and 8 quarter averages. However, NFLX is trading near an all-time high in price, so the $36 implied move is much lower in percentage terms today than it has been in the past. Another reason for the low relative options pricing is the low volatility in the broader market.
Our View: NFLX has been a terrific investment over the past 2 years, steadily moving higher with no major selloff until this spring’s March/April swoon. The stock has recuperated and rallied to new highs since then. We view the long-term risk/reward in NFLX as skewed to the downside, especially as obstacles mount as the company grows. That long-term view, however, has little bearing on the short-term price action, which has been especially erratic, and driven much more by psychology, technicals and positioning. With that in mind, we don’t plan a trade before earnings on this one.