Growth stocks are feeling the heat. A change in dynamics around monetary policy has led investors out of high valued tech and into cyclicals (banks, energy, etc) and in some cases the sidelines.
Netflix (NFLX) was the first major tech/growth company to report its Q4 earnings. It made the cardinal sin of missing expectations in a skittish market environment, opening the door to intense selling.
What had investors so concerned and, more importantly, did we just get a buyable flush in Netflix?
The dive in NFLX may have come as a surprise to some. NFLX hit an all-time high of $700 on November 17 but saw a 26% haircut in the weeks ahead of earnings. Shares were down 6% over the prior 52-week period compared to a 21% run in tech ETF XLK. Disappointing results had surely been priced into NFLX?
Well in a bear market, sentiment can outweigh common sense, just like a bull market can create irrational exuberance. Both trends create opportunity.
The key metric for Netflix is subs and it added 8.3 million users in Q4. This was a light of the 8.5 million target and the lowest Q4 add since 2017.
The company’s Q1 outlook was even more concerning as they projected adding 2.5 million subs, well below analyst expectations of 5.7 million.
The revenue numbers were not much better. Q4 revenue were in line with expectations but NFLX forecast Q1 revenues of $7.9 million which missed the consensus expectation of $8.2 million.
Operating Margin raised red flags. NFLX forecast operating margin in the range of 19-20% which was below the 20.8% posted in 2021. A key reason for the decline in operating margins is a lack of pricing power in the higher growth International markets. Product mix will continue to be an issue for the company as International makes up 60% of revenues.
The news led to a slew of downgrades and price target cuts. The stock was decimated, tumbling 20% in reaction to the report. The stock is now down 44% from its 52-week high.
NFLX is now trading at pre-pandemic level. We must go back to 2017-2018 to find support levels on the chart. But there are opportunities in this $350 area.
Valuation remains a concern. The stock trades at 26x forward earnings. Not as outrageous as the 50+ it was at in November but the Q4 revenue growth of 16% is down compared to 20% in 2021, 24% in 2019, 27% in 2018 and 35% in 2017.
The company has improved its bottom line. While it warned of higher dollar costs it anticipated being cash flow positive for the full year of 2022 and beyond. It will use this excess cash to pay down its debt in 2022. After satisfying these goals it will turn its attention to share buybacks.
Netflix had issues with subs in the quarter, but it did add 55 million subs (approximately 33%) over the past two years. There was certainly some pull forward at play around the pandemic (it added a whopping 15 million subs in 2Q20). The company downplayed the impact from competition, but those concerns will remain. A new season of Ozarks and Bridgerton could lead to a surprise beat in Q1 against very low expectations.
Churn and engagement remain firmly in the company’s favor. NFLX will raise prices in the United States. That means we will need to keep a close eye on these two metrics to make sure NFLX has the pricing power needed to expand margins.
Overall, NFLX sets up as a name to accumulate. Valuation is high but the 44% haircut has washed out a lot of sellers and opened up a more reasonable entry. NFLX has earned a premium valuation given its first mover advantage in the streaming video segment which has an addressable market of $82 billion in 2022 according to Statista.
There will be gyrations in the market as we continue to adjust to new monetary policy. But investors can begin to slowly build a position in this name and, at the end of the day, set up a nice position in a market leader in a growing industry. We may not be able to chill out in this position for a few weeks but building positions between $350-400 will turn into a nice set up.