As Netflix (NASDAQ:NFLX) prepares to report earnings after the markets close on July 20, there’s a lot of noise surrounding NFLX stock. Some investors are focusing on the Delta variant of Covid-19 which is causing many countries to revisit strong mitigation efforts.
Others are focusing on the company’s recent announcement that it would be expanding into video game content. This is a logical next step for the company.
Still, others are looking at the new subscriber numbers. For a business like Netflix, subscriber growth is becoming a benchmark in the same way that same-store growth is for retail stocks. And it takes on even more significance as more competitors compete in the streaming space.
All of those are newsworthy, and any one of them could cause NFLX to break out of its doldrums. I have to admit that I haven’t paid close attention to the stock and was surprised to find that it’s only up 4.6% in the last 12 months. This is despite the fact that the company has become synonymous with consumer activity during the pandemic.
So I’ll stop teasing my lead and get to the question I think is most important: what about that debt? More specifically, is Netflix still on a path to not undertake any more debt?
Why the question matters
In January of this year, Netflix announced that it would no longer need external funding to finance operations. At the time the news sent NFLX stock soaring to its 52-week high.
But that sentiment didn’t last long. Neftlix continues to trade in a range. And if bullish investors wanted something to be concerned about, it could be that the stock is showing a pattern of lower highs and lower lows.
In the early days of Netflix, the idea that it was taking on debt was something of a non-issue. This was a textbook example of spending money to make money. And subscriber numbers were growing so rapidly, the company's high debt load was not the story.
But Netflix is growing up. It’s unquestionably the leader in the streaming space. However, it’s also going to find eye-popping new subscriber growth more difficult to come by. Maybe a better way to look at it is the low-hanging fruit is gone. This means that investors are going to stop grading Netflix on a curve and start expecting financial results that are in line with an established market leader.
So far, so good
In the last 12 months, Netflix has generated free cash flow (FCF) of $2.4 billion. A good bit of that growth was due to the unprecedented circumstances that were brought about by the pandemic. This has helped Netflix pay down its debt even as it continues to spend money to create new content.
However, for Netflix to become the self-funding company it wants to be (and that investors need it to be) that number will have to increase. The earnings report will be a barometer for that growth.
What could go wrong?
Netflix is still going to have to create new content. Whether that’s in new video games or Season 5 of The Crown. And that means the company will still be burning cash. In fact, the company expects to spend $17 billion on new content this year.
But how long will investors who have looked at NFLX stock as their “ride or die” be willing to hang on if the company chooses to depress shareholder value by spending excess cash on new content?
And on the flipside what will growth-minded investors do if Netflix begins to issue share buybacks? On the one hand, the company would be signaling that it’s a mature company. However, that might also take away some of the growth stock appeals that NFLX stock has enjoyed.
Expect more of the same for NFLX stock
If the whisper number means anything, it should be a good afternoon for NFLX stock. The company is expected to beat on earnings and post a sequential gain in revenue. But, in my opinion, investors would be better served by ignoring the shiny objects in the form of news stories that surround Netflix and just focus on the fundamentals.
Netflix is now a young adult and with that comes the privilege of expectations. But that may come at the expense of short-term growth. I see NFLX stock as a Hold, but stranger things (pun intended) have happened.
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