Netflix, Inc. (
NasdaqGS: NFLX) provides online movie rental subscription services in the United States. The company offers its subscribers access to a library of movie, television, and other filmed entertainment titles on digital versatile disc (DVD). Its members can get DVDs delivered to their homes and can instantly watch movies and TV episodes streamed to their TVs and PCs.
The stock has performed strongly so far this year, gaining almost 38% versus the S&P 500's gain of only 4.5%. That is an amazing performance and means that there are a lot of bullish expectations embedded to the stock. In order to produce further gains, the company will have to deliver exceptional results going forward. I believe that Netflix is vulnerable to downside at these levels.
The company is doing well, so this is largely a valuation call. The stock is currently trading at 23.8x current year estimates of $1.73 per share, which is well above the market's multiple. Any sign that its business is slowing down will give the stock a pretty significant haircut. However, the company is still enjoying solid business momentum at the moment.
Netflix reported strong first-quarter earnings at the end of April. It said that earnings came in at 37 cents per share, a full 15.6% above estimates. Management also guided higher for the full year. The midpoint of its earnings per share range rose to $1.64 from $1.51. "First quarter results showed strong momentum driven by consumer attraction to our unlimited rental proposition," said Reed Hastings, Netflix co-founder and chief executive officer. "We added more net subscribers than in any previous quarter in our history and grew year-over-year GAAP EPS by 76%."
The fact that the stock sold off on heavy volume should have sounded alarm bells as to the future performance of the stock.
By most accounts, this was a fabulous quarter, but digging a little deeper revealed why investors sold. The company's churn rate ticked up to 4.2% from 3.9% during last year's quarter. Management said that it would add about 200,000 new subscribers in the second quarter which is rather underwhelming. Investors also didn't like the fact that subscriber growth was weak in the last half of the quarter.
I agree that these seem like less than urgent points given the great overall numbers, but that's what happens when the stock is priced for perfection. Another reason for concern is competition. CEO Reed Hastings expects DVD rental kiosks from Redbox to be stiff competition by the end of the year. These kiosks only charge $1 per day and have been placed in
Wal-Mart and 7-Eleven to name a few places. Many customers have canceled their Netflix subscription due to these kiosks.
Despite an overvalued stock, the company does have some growth opportunities. Streaming movies over the internet is one area that Netflix can tap into. The CEO doesn't want to exclusively do this, but it is one area that can stoke growth. Customers mostly prefer to see them online rather than waiting for the DVD to come in the mail.
Additionally, the company's partnership with the Xbox360 is quite interesting.
To reiterate, Netflix has solid fundamentals going for it, but I would be much more enthusiastic about the stock if it were in the mid-$30's rather than its current quote of about $41.
