Friday, June 15, 2018

Citron's Netflix Report Left One Word Out

Citron Research, who has had some strong calls in the past has again gone after Netflix (NASDAQ:NFLX). We need to pay attention but we think he's missing one key word; earnings.

He cited increased competition coming from AT&T and Time Warner and listed many drivers that could tumble Netflix.

He also went after a Goldman analyst that raised their target by upping their EV/EBIDTA multiple.  We agree that raising a multiple is a lower quality method to chase a stock.

That said earnings growth has been accelerating and that's the real story here.

Need To Pay Attention To The Missing Word In Citron's Report, Earnings

Full disclosure, Citron did mention the word earnings but not in its context...

Citron said,

"On NFLX’s Q1’18 earnings call, Hastings noted: “We'll spend over $10 billion on content and marketing and $1.3 billion on tech… we're much more of a media company in that way than pure tech."

That was the only mention of the word earnings but Netflix is turning into an earnings story as we've been talking about.

And direct to Citron's point of "$10 billion on content and marketing" Netflix is saying that the spend is starting to grow slower than revenues which drives profit leverage and faster earnings.

Here's what Netflix said on their last earnings call.

"Well, you're definitely seeing revenue grow faster than content already, and that's where operating margin is coming from." 

Netflix went on to say, "We think we're after a big opportunity, and the bigger the business we are, the higher that margin could be. We're certainly not down [for margins]."

So while the absolute spend number is an eye-popping $10 billion, they are starting to lever those expenses which means this earnings story is getting better, not worse.

That was on their April earnings call.

On their January earnings call they said,

"...working capital needs on content start to moderate."

Netflix continued on that content spend,

"...but we are seeing some of those pressures moderate a bit."

So the years of huge growth of content is starting to moderate just as their revenues are accelerating. Netflix' largest expense is moderating. If so, which way will earnings growth go? We think higher.

EPS Growth Accelerating

With revenues on fire and their costs not matching revenues earnings have been accelerating at Netflix.


2015 2016 2017 E'18
Year EPS 0.26 0.42 1.25 3.69
Growth -59% 62% 198% 195%

2017 earnings were up almost 200% and that's what we have modeled for 2018 based on their accelerating revenue trends.

Our 2019 number though is how we're valuing Netflix. Our 2019 expectation is for $6.50 versus the Street's $4.59.

We're using a 100 PE which is half the 200% growth rate. A PEG ratio of .5 is actually cheap while everybody perceives Netflix as expensive.

Conclusion

Citron has had some amazing calls like Valeant (NYSE:VRX). Netflix, though is a tough one to step into the ring with. The stock has had a monster run which brings on shorts. But we have our eye on the prize which is the potential for a 2019 EPS estimate of $6.50. We respect their calls but we think the real driver is earnings.


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We have no position currently but are planning to open a position on a pullback.

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