Earnings Preview – Netflix ($NFLX)

by Dan July 15, 2015 11:31 am • Commentary

Event: NFLX reports Q2 earnings tonight after the close. The options market is implying about a 10% one day earnings move, which is shy of the 15% 4 qtr avg and the stock’s all time avg of about 13%.  Over the last 16 quarters there have only been four one day moves of less than 10%. You get the point, the stock tends to have violent movement post results. Oh and the stock has sold off on each day following the Q2 reports over the last five years, with the average decline of 10.5%:

from Bloomberg

Price Action / Technicals:  NFLX is up 105% ytd, having just made a new all time high on Monday, now just 2% below.

The one year chart shows the prior two gaps following better than expected earnings.  The stock has held the uptrend that has been in place for most of 2015, with the May/early June consolidation at $90 a healthy support level:

[caption id="attachment_55339" align="aligncenter" width="600"]NFLX 1yr chart from Bloomberg NFLX 1yr chart from Bloomberg[/caption]

Sentiment:  Despite NFLX being the best performing stock in the S&P500 in 2015, Wall Street analysts remain very mixed on the stock with 22 Buy Ratings, 16 Holds and 6 Sells, with an average 12 month price target of about $92, well below where the stock is currently trading. Short interest sits at about 7%.

Valuation: It’s impossible to invest in/trade NFLX without considering its valuation, and the potential for the stock to grow into it.  Bulls would argue that it continues to trade at levels that make sense given its first mover advantage, scarcity value and overseas growth potential.  Many would point to AMZN to help prove the point that a great service, and great company can have a stock that is unhinged from reality for a very long time. That thought process has been the right one for the last year in these two stocks, but that does not mean that it will continue to be right going forward.  This week David Einhorn, founder of very successful hedge fund Greenlight Capital sent a shot across the bow of NFLX bulls in his Q2 investor letter, taking a cynical stance towards the stock:

On April 15 after the close, Netflix (NFLX) announced its results for the first quarter and conducted a conference call. NFLX shares had already risen 39% in 2015 and were trading at more than 100x 2016 estimates with analysts expecting adjusted earnings for the quarter of $0.63. NFLX achieved just $0.36. Prior to the call, the June quarter consensus stood at$0.86; by the next morning consensus was $0.30. All told, analysts slashed estimates for the next three years.
The shares opened the next morning 12% higher and never looked back. By the end of the quarter, the shares had almost doubled for the year, making NFLX the best performing stock in the S&P 500 by far.
Why did the stock react that way? Cynically: if it soared on bad news, imagine what it would do with good news. Practically: NFLX changed its story and pushed its promises into the distant future, with grand hopes for the decade starting in 2020. It transitioned from being a company judged by how much it earns into a company judged by how much it spends. Whether the spending proves successful won’t be known during the investment horizon of most NFLX shareholders. In today’s market, the best performing stocks are companies with exciting stories where accountability is in the distant future

It’s really hard to argue with David Einhorn’s investment thesis on any security, his track record speaks for itself, but like all investors he can be wrong. He was very right on Micron (MU), as one of its largest and most vocal shareholders for all of 2014, and very wrong for all of 2015.  Guys like Einhorn have one thing that most of us regular people don’t have, and that’s deep pockets, which allows for time to let a contrarian thesis play out.  Whether the stock will react negatively to (obviously) poor financial performance, or merely focus on subscriber additions, I have no idea, and it sounds like he does either. But at some point investors will become more discerning.

Volatility Snapshot:  While the implied move is lower than the average move, it is important to note that while the implied move looks cheap to the average historical move, for the last two quarters the implied move has been about 10% the day of the report, and the stock has rallied 18% and 17% respectively.

Following the results, short dated options prices generally get cut in half:

[caption id="attachment_55342" align="aligncenter" width="600"]NFLX 1yr chart of 30 day at the money IV from Bloomberg NFLX 1yr chart of 30 day at the money IV from Bloomberg[/caption]


Estimates and Forecasts from Bloomberg:

-2Q EPS (pre-split) 29c; co. forecast 26c (April 15)
-2Q EPS (post-split) ~4c
-2Q rev. $1.65b (range $1.63b-$1.68b)

-NFLX forecast 2Q domestic streaming net adds 0.6m
-NFLX forecast 2Q international streaming net adds 1.9m
-3Q EPS 33c (pre-split); 3Q EPS ~5c (post-split)

My View:  The company has delivered on their promise of growing subs domestically with signs of a very healthy runway internationally.  The multi-billion dollar question is whether or not competition from content providers in the coming quarters causes growth to slow, and investors to arrive at the logical conclusion that the stock’s multiple does not adequately reflect what will be an increasingly competitive streaming media environment.  I would not be a buyer of the stock here. While the ytd move looks like it has been easy, I suspect longs haven’t felt at ease. And from here on out it gets much harder. Sentiment seems to very bullish with more than 5 price hikes in the last few weeks, and the enthusiasm from retail investors surrounding today’s 7 for 1 stock split.

We’re going to look at some ways to fade this recent run-up in the stock which we think is largely a result of people buying in advance of the stock split. We’ll circle back today in a another post.