• The Netflix (NASDAQ: NFLX) stock price grew by 46.22% of the past year on the back of increasing demand for on-demand video streaming services. However, increased competition and loss of major titles to rivals such as Disney+ seemed to encourage the bears. 
  • In the Q4 fiscal 2020 financial report, Netflix silenced the bears by adding 8.5 million paid customers against a consensus estimate of 6.2 million. Paid net adds (PNA) growth in all regions came above Q4 fiscal 2019 levels due to recovering gross ads and reduced churns. It is noteworthy that about 83% of Netflix’s reported PNA came from overseas markets, which is a testament to its heterogeneous membership base.
  • The larger subscriber count raised Netflix’s revenue to $6.64 billion in the quarter against an estimated $6.62 billion. Netflix also revealed that it expects to turn FCF positive in 2021 after years of dependency on debt financing. 

Free cash flow (FCF) is no longer a cautionary flag for Netflix

Netflix had a pleasant surprise for investors and analysts when releasing the financial report for Q4 FY2020. In the report, Netflix smashed various estimates, with the most important being the paid net adds (PNA), coming out at 38% above the estimated value of 6.2 million. 

According to the report, Netflix’s operating income for the full year 2020 stood at $4.59 billion compared to $2.60 billion for 2019. The operating margin specifically for Q4 2020 came in at 14.4%, also beating estimates. But beating estimates is not the only positive thing about Netflix’s operating income. 

For the first time in the company’s financial history, Netflix achieved a positive current cash value in the quarter. Netflix reported that it intends to repay bonds maturing in early February 2021 using cash on hand. Also, the company intends to launch a share buyback program to return profits to shareholders. The highlight of the report is that Netflix’s management is anticipating breaking FCF even this year. This is important considering that the company was $1 billion below break-even level same time last year. 

About Netflix Inc.

Netflix is a Video Streaming market titan founded in August 1997 in Scotts Valley, California. The company later moved its main offices to Los Gatos, California. Over 23 years, Netflix grew from a DVD rental business into the world’s largest video streaming service. Initially, the company aggregated television series and films from other producers, but it is increasingly leaning towards in-house produced content. 

Rapid success in the Americas convinced the company’s leadership to take it fully international. Netflix now boasts a user base of paying subscribers of approximately 203.67 million coming from more than 190 countries. US-based Netflix subscribers account for around a third of the company’s global user base. 

Now, users can stream a wide range of entertainment and educational content across many genres and languages. Users can enjoy hours of content without ads at any time and anywhere as long they can access the internet. 

No more funding of daily operations through external financing channels

Businesses take time from founding until they break even. During this period, the management funds day-to-day operations through loans and commercial papers. A strong performance during the 4Q FY2020 has suddenly turned things around for Netflix. 

Netflix expects to build on the strength to increase the revenue share in the coming quarter. In its guidance for Q1 FY2021, the company expects paid net increases by 6 million and revenue to come in the region of $7.13 billion. During this quarter, Netflix management anticipates the company’s FCF outlook to be “around break-even.” 

Achieving FCF break-even is crucial for Netflix because it means the company will have enough cash on hand to cover operational costs. As per the latest financial report, Netflix’s total assets are valued at $39.28 billion against $28.22 billion of total liabilities. Further evidence of Netflix’s strong financial health is the improvement of the debt-to-equity ratio, which has significantly reduced from 206.3% at the end of June 2019 to 147.4% as of Q4 FY20. 

One might argue that NFLX’s strong 4Q FY20 was by chance, and the Covid-19 pandemic buoyed that. As such, the market expects paid net adds to increase at a slower rate in the coming quarter. While these expectations are not unfounded, one could also argue that the pandemic might have entrenched a dynamic shift towards on-demand video streaming that might never reverse. 

Can NFLX stock better its performance so far?

The NFLX stock is up 46.22% over the past 12 months of trading. January 2021 was an exciting period for the stock, which contributed greatly to the 16.09% rise over the past three months. NFLX’s insane popularity after 4Q FY20 financial results injected extremely high levels of volatility in the stock. For instance, the stock price jumped from $455 on January 22 to $604 just two days later – on January 26. 

NFLX price chart

However, this picture changes when we add the Average True Range (ATR) on the NFLX price chart. As you can see in the figure below, the price action of the stock has been stabilizing.

NFLX price chart

The decreasing volatility should be great news to value traders. On the one hand, momentum traders – who are often impatient and keen on quick profits – are exiting the stock. This means the stock is declining back to true valuation. On the other hand, the decreasing volatility signals reduced risk. A less risky NFLX is more attractive and is prime for investing.

Conclusion

The video streaming market is still young. Even Netflix management acknowledged that the addressable market is underappreciated. With a serious push into international markets, Netflix is positioning itself to grab even more market share and, as a result, higher revenues. 

If the current pandemic deals a permanent blow on the previous way of life, then the market should start getting used to stellar performances such as 4Q FY20 from Netflix. Even then, there are plenty of opportunities for the company to replicate the performance without the pandemic, which convinces us to rate NFLX as a BUY.