* Reports Q4 2019 results on Tuesday, Jan. 21, after the market close
* Revenue Expectation: $5.45 billion
* EPS Expectation: $0.52
When the streaming entertainment giant Netflix (NASDAQ:NFLX) reports its 4Q earnings later today, it must show that it continues to add paid subscribers at a pace fast enough to keep the company ahead of the competition.
The shares' 25% surge since their September low indicates that investors have that outcome already baked into their expectations. After missing analysts' second-quarter earnings estimates, Netflix added 6.77 million subscribers in the third quarter, with stronger-than-expected growth overseas.
This helped allay investor concerns that growth is peaking just as several new, deep-pocketed players, such as Disney (NYSE:DIS) and Apple (NASDAQ:AAPL) introduce their own streaming services.
Worries over competition and Netflix’s stagnating growth in its home market are mainly behind the stock’s underperformance in the past 12 months. Its shares hardly budged during this period, while other mega-cap tech stocks set records. Netflix closed Friday at $339.67, down 20% from its record high in June, 2018.
Today’s earnings release represents a key test for the stock as it will be the company's first report since the November launch of the Disney+ streaming service, which hooked up millions of subscribers almost immediately. Comcast's (NASDAQ:CMCSA) NBCUniversal last week unveiled its own streaming platform, while AT&T's (NYSE:T) WarnerMedia is expected to launch its platform in May.
Growth Vs Spending
The biggest challenge for Netflix in this dynamic situation is how to maintain a fine balance between growth and spending. The company’s huge content and marketing budget can only be justified if the company is adding more subscribers. If that doesn’t materialize, then its stock has to reflect that reality, especially when Netflix is borrowing to fuel growth. The company is expected to burn through nearly $2.7 billion in cash this year.
Funding growth through debt is a risky model that makes Netflix stock vulnerable. The Los Gatos, California-based company will continue to use the junk-bond market to finance its programming costs, which are expected to total about $15 billion this year.
What if subscriber growth in its most lucrative market continues to slow and the company keeps burning more cash each year to cover the cost of its success? Recent price hikes have helped Netflix to grow its profit and revenue, but that strategy has its own risk, especially when consumers see more streaming options becoming available. After last year’s subscription fee hikes, Netflix is forecast to post its weakest growth in the U.S. in years, adding just 2.7 million customers in 2019.
These threats make Netflix a risky bet in 2020. Options traders are forecasting a large swing for the shares, projecting a move of up to 7.7% after the company reports earnings today, according to data provider Trade Alert. That is above the average 6% move recorded after the last eight earnings releases.
Bottom Line
Highlighting these risks doesn’t mean that we don’t like the shares. In our view, Netflix is a great success story which has totally re-shaped the media entertainment industry. We believe the company still has the potential to produce many more blowout quarters on the strength of its content, wide global appeal and superior technology.
But with the upcoming competition, rising content costs and saturation in the domestic market, the path forward won’t be that easy. In our view, Netflix will continue to lag behind other mega tech stocks until investors are able to see a clear sign that the company is holding up well and can defend its turf. Strong subscription growth in 2020 is crucial to achieving that outcome.