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Netflix - subscribers beat target, but much lower than last year

Sophie Lund-Yates, Equity Analyst | 21 July 2021 | A A A
Netflix - subscribers beat target, but much lower than last year

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Netflix Inc Common Stock US$0.001

Sell: 641.77 | Buy: 641.78 | Change -21.94 (-3.31%)
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Netflix added 1.5m new global paid subscriptions in the second quarter. That's better than guidance of 1.0m, but down on the 10.1m added this time last year, and the 4.0m added last quarter. The group highlighted that paid memberships in North America and Canada fell slightly, due to the ''large membership base'' and ''seasonally smaller quarter for acquisition''.

Revenue rose overall, helping operating profit rise 36% compared to last year, to $1.8bn.

The shares were broadly flat in after-hours trading.

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Our view

Putting it frankly, subscriber growth is the only number that really matters.

The pandemic has been a double-edged sword on that front. On one hand, stay-at-home-orders triggered a deluge of new subscriptions last year, helping profit and cash flow on the way. But on the other, 2020 simply poached growth from further down the line. While Netflix beat its subscriber targets in the second quarter, growth was significantly lower than usual.

Continuing to grow the user-base is crucial. It allows Netflix to spread its rather enormous costs across a larger customer base, which is what will allow it to become cash flow positive. Netflix spends $11bn+ a year on new content, and this spending is pretty non-negotiable. Competition in the space is fierce, thanks to the likes of Amazon and Disney+. Stopping your subscribers from switching to a rival means you have to offer the latest must-watch.

We're encouraged to hear that existing subscribers are sticking with Netflix for now. But keeping new customers is the hard part. That's a large reason behind the decision to step into gaming. A very high proportion of younger people already have a Netflix subscription, so getting them hooked on games by leveraging its original content is a good move. It will also play into Netflix's core strategy, which is to make more money from developed markets by increasing prices. This should be an easier job thanks to the pandemic, as streaming has become even more of a habit than it was before. A nice idea, yes, but there's little proof of success at this early stage.

We can't knock the huge increases in profits, and the fact Netflix no longer needs to rely on external financing. This is great news. The group's even comfortable enough to start returning up to $5bn via buybacks, which shouldn't be overlooked.

There are some structural growth opportunities too. The pull of box office hits is much less potent these days - instead people are continuing to look for smash content from the comfort of their sofas. We think this could be a long-term behavioural shift. The group's head-start in local language content is also a real asset. As the more mature US and Canadian regions start to plateau, adding new subscribers will be the responsibility of emerging markets.

Let's not forget that streamed content is the new normal. And Netflix isn't just in the game, it had a hand in inventing it. The rest of the year is crucial. It will signal how firm a grip the group has on plans to build scale. If it can't do that, the outlook for cashflow will be less chipper, and Netflix would be in the spotlight for all the wrong reasons. For now Netflix still has the upper hand, but we'd be lying if we said there isn't a lot of work to be done.

Netflix key facts

  • Price/earnings ratio: 44.4
  • Ten year average Price/earnings ratio: 132.9
  • Prospective dividend yield (next 12 months): 0.0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Second quarter results

Netflix plans to add 3.5m new subscribers next quarter.

Excluding the impact of exchange rates, average revenue per user (ARM) rose 4%. The strongest growth came from Netflix's biggest market of North America and Canada, which rose 9% to $14.54. Europe, Middle East & Africa and Latin America both rose just 2% to $11.66 and $7.50 respectively, while Asia Pacific was up 1% to $9.74.

Growth in subscribers and ARM meant reported revenue was up 19.4% to $7.3bn.

Netflix said it plans to expand further into games, viewing this as a ''new content category''. Games will be included in subscriptions at no additional cost, with the group initially focussing on mobile games.

$8.0bn has been spent on content so far this year. Free cash flow swung from $899m to -$175m, as last year's production shutdowns preserved cash, but sets are now back up and running. Netflix still expects to be free cashflow neutral at the full year.

Net debt at the end of June was $7.8bn, compared to $8.1bn at the start of the year.

$0.5bn of the $5.0bn share buyback programme has been completed.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.