Wednesday, October 20, 2021
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Netflix Stock – Netflix‘s Growth Is Slowing: Does It Matter?

Netflix (NASDAQ:NFLX) gave shareholders an unwelcome surprise when it released its first-quarter results on Tuesday. The streaming video giant reported its biggest miss on subscriber growth in nearly two years.

Management blamed the miss — and the slowdown in subscriber growth — on temporary factors related to the COVID-19 pandemic. However, the bulk of the evidence suggests that Netflix‘s underlying growth rate is slowing, too. That doesn’t necessarily mean Netflix stock is doomed, but it does suggest that investors need to prepare for turbulence ahead.

Growth slows again

In the first quarter of 2020, Netflix added 15.77 million paid subscribers. That easily set a new record for subscriber growth, as consumers flocked to at-home entertainment options in the midst of pandemic-related lockdowns.

Netflix didn’t expect to repeat that feat in the first quarter of 2021. Three months ago, management projected that the company would add 6 million paid subscribers in Q1. Even that forecast proved too optimistic. Net paid additions totaled 3.98 million for the quarter.

A <a href=Netflix content screen for its original show Stranger Things” src=”https://g.foolcdn.com/image/?url=https%3A%2F%2Fg.foolcdn.com%2Feditorial%2Fimages%2F622404%2Fconsumer-goods-streaming-media-netflix-nflx-content-screen.jpg&w=700&op=resize” srcset=”https://g.foolcdn.com/image/?url=https%3A//g.foolcdn.com/editorial/images/622404/consumer-goods-streaming-media-netflix-nflx-content-screen.jpg&w=300&op=resize 300w, https://g.foolcdn.com/image/?url=https%3A//g.foolcdn.com/editorial/images/622404/consumer-goods-streaming-media-netflix-nflx-content-screen.jpg&w=1000&op=resize 1000w, https://g.foolcdn.com/image/?url=https%3A//g.foolcdn.com/editorial/images/622404/consumer-goods-streaming-media-netflix-nflx-content-screen.jpg&w=2000&op=resize 2000w”/>

Image source: Netflix.

Netflix executives encouraged investors not to worry too much about the subscriber miss. They noted that it was very difficult to develop accurate projections during the pandemic and that growth had far surpassed the company’s forecasts several times in 2020. CFO Spencer Neumann added that Netflix faced two discrete headwinds last quarter. First, the pandemic pulled some growth forward into 2020. Second, pandemic-related production shutdowns delayed some key content releases (which tend to drive sign-ups).

However, this explanation isn’t entirely satisfactory. After a surge in growth in the first half of 2020 and a big slowdown in the third quarter, Netflix‘s fourth-quarter 2020 subscriber additions came within 3% of the year-earlier figure. The streaming video leader’s growth pattern had apparently returned to normal. By contrast, Netflix added less than half as many paid subscribers last quarter as it did in the first quarter of 2019.

The slowdown will likely continue

Netflix‘s slowdown in subscriber growth will likely continue in the second quarter, which tends to be seasonally weak anyway. Management projects that Netflix will add just 1 million paid subscribers this quarter, compared to over 10 million a year ago and 2.7 million the year before that.

During Netflix‘s earnings call, management tried to reassure shareholders by asserting that growth will reaccelerate in the second half of 2021. Yet while the company can do better than the anemic growth it is posting in the first half of 2021, investors shouldn’t expect a return to its pre-pandemic growth rate.

After all, growth was already slowing in the mature U.S. and Canada markets in 2019. The short-term bump in subscriber growth last year got Netflix even closer to saturating those markets.

Image source: Getty Images.

Moreover, the EMEA (Europe, Middle East, and Africa) region has been the biggest contributor to Netflix‘s recent growth. The pandemic has been an ongoing tailwind there, as many European countries implemented new lockdowns in late 2020 and early 2021. As Europe reopens over the next few quarters, growth could slow dramatically in this key region.

Less growth, more profit

Just prior to the pandemic, Netflix‘s subscriber base was growing about 20% annually. With many of its older markets nearing saturation, I expect annual subscriber growth to moderate to around 10% within a couple of years.

Yet while growth is slowing, profitability is taking off. Operating income doubled to nearly $2 billion last quarter. As long as Netflix can continue raising prices periodically, it will be able to keep revenue growth comfortably in double-digit territory while growing its margins. That will support strong profit growth.

In the near term, slower growth could spook some investors. Apple stock struggled for several years following the iPhone 5 release in late 2012, as investors worried about slowing revenue growth. However, Apple stock has regained investors’ favor since then. In fact, Apple shares have quintupled over the past five years, even though the company has averaged single-digit revenue growth during this period.

<a href=AAPL Chart” src=”https://media.ycharts.com/charts/0928ae387432169cc095727de0f873b5.png”/>

Apple revenue and stock performance, data by YCharts.

Similarly, earnings and free cash flow are becoming more relevant metrics for Netflix than subscriber growth. If the company can sustain high profit margins, slower growth shouldn’t prevent Netflix stock from performing well.

Of course, the NetflixApple comparison isn’t perfect. Apple stock traded at a bargain valuation of just 10 times earnings five years ago. By contrast, Netflix stock still trades at a big premium to the market. Moreover, management may be setting investors up for future disappointments by downplaying the likelihood that growth will be slower going forward.

Netflix stock could remain volatile as investors come to grips with its slowing growth. But that could eventually lead to good buying opportunities for long-term investors if Netflix‘s profit growth remains on track.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Fintech Zoom premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.



Netflix Stock – Netflix‘s Growth Is Slowing: Does It Matter?

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