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Netflix - strong Q1, but more cash outflows bring mixed reviews

George Salmon | 17 April 2019 | A A A
Netflix - strong Q1, but more cash outflows bring mixed reviews

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Netflix Inc Common Stock US$0.001

Sell: 298.34 | Buy: 298.44 | Change -0.49 (-0.16%)
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Netflix gained another 9.6m subscribers in its first quarter, including 1.74m US net additions. That takes the customer base to 148.9m, which is ahead of prior forecasts.

However, the group's guidance for Q2 additions is slightly behind what had been hoped for, and 2019's cash outflows are set to be higher than expected.

The shares moved marginally lower in after-hours trading, tempering some of the gains from earlier in the day.

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Our view

Video killed the radio star, and by leading the on-demand revolution, Netflix is looking for cable's crown.

Rapid growth means revenue has been something of a blur. After posting $4.3bn in 2013, it topped $15.5bn last year. Impressive stuff, especially when you consider subscription revenue is by definition very likely to recur year-on-year.

We also think the group has plenty of room to increase prices. Subscriptions cost around £8 a month, and the average user spends around 10 hours a week on the service. That's under 20p an hour. And with Netflix viewing time still dwarfed by conventional TV, there's plenty of scope for users to get even more value for money as streaming increases its share.

A lack of competition means Netflix has enjoyed a relatively easy ride so far. That won't be the case for long. Amazon, Apple and Disney are all expanding.

To keep adding new customers and entertain its existing audience, Netflix is spending heavily on marketing, while the content budget has burst past $10bn a year. This includes making Netflix originals - think House of Cards, Bird Box and Ozark - and licenced content from other production houses.

That spending means Netflix is burning through cash. However, it's been able to plug the gap with affordably priced debt because the market is optimistic it'll be taking in more than it spends in the not-too-distant future. Once that happens the scalability of the business means cash flow could improve rapidly. This helps explain the shares' premium valuation of 77 times expected earnings.

So far Netflix has generally delivered the growth that high rating demands. However, the pace of expansion from quarter to quarter has proven difficult to forecast. That volatility, plus the heightened risk/reward that comes with a rapidly evolving landscape, means the share price has moved sharply in both directions over the last year.

Looking ahead, we tend to agree with Netflix CEO Reed Hastings that the size of the opportunity means there will be room for more than one streaming service in most households, so there could be room at the table for everyone. However, there's always the risk the US streaming giants start clashing elbows sooner than expected.

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First quarter trading details

While currency movements more than offset the impact of Netflix's price increases in the US, Mexico, Brazil and parts of Europe, increased subscriber numbers ensured first quarter revenue rose 22% to $4.5bn. Excluding those currency movements, revenue rose 28%, with average revenue per user up 3%.

With margins of 10.2% holding up better than forecast, earnings per share beat expectations in rising from $0.64 to $0.76. However, that was mostly due to anticipated spending being pushed back to later in the year, and a $58m gain from revaluing euro-denominated debt.

Content spending of $3bn, which is yet to make its way onto the income statement, ensured free cash flow was again negative, at -$460m, compared to -$287m a year ago. The full year's cash outflow is set to come in at around $3.5bn. That's courtesy of higher taxes and investment in property and other supporting infrastructure.

Still, Netflix remains confident free cash flow will improve in 2020 and each year thereafter, driven by top line growth and increasing operating margins.

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