After announcing its strong fourth-quarter earnings results, the share price of Netflix Inc. (NFLX, Financial) has surged significantly, from $492 to almost $558.50 per share within three days. After the recent rally, the stock has gained 57% over the past 12 months, only 14.50% lower than its all-time high recorded in November 2021. After the recent bullish market momentum, I believe Netflix is now fairly valued.
Global reach and content strategy
A global leader in streaming, Netflix has managed to grow its subscribers consistently over the past decade. Its subscriber count has significantly increased by 7.60 times, from 34.24 million in the first quarter of 2013 to 260.28 million in the fourth quarter of 2023. To attract and retain streaming users, the company has made heavy investments in original content production, content acquisition and licensing agreements.
Source: Statista
Rising revenue and operating income
Over the past 20 years, Netflix has consistently grown its revenue and operating income. Its revenue has steadily increased from $272.24 million in 2003 to $33.70 billion in 2023, delivering a compounded annual growth rate of 27.20%. Its operating income has also followed a similar trend, rising from $4.50 million to $6.95 billion over the same period, representing a remarkable compounded annual growth rate of 44.40%. Although its operating margin has fluctuated, ranging from 1.39% to 13.12% between 2003 and 2015, there has been a consistent and decent improvement over the past seven years. From 2016 to 2023, the operating margin has surged from 4.3% to over 20.6%.
Cash flow dynamics
Despite the increase in revenue and operating income, Netflix experienced minimal and subsequent declining operating cash flow and free cash flow from 2014 to 2019. However, following this period, its cash flow generation began to trend upward, culminating in a significant rise by 2023. Specifically, in 2019, Netflix's operating cash flow deteriorated to -$2.89 billion, alongside a negative free cash flow of $3.14 billion. In contrast, by 2023, these figures had dramatically improved, with operating cash flow soaring to $7.27 billion and free cash flow increasing to $6.93 billion.
The earlier negative operating cash flow and free cash flow were largely attributed to its substantial investments in content assets. These investments grew significantly, from $8.60 billion in 2016 to over $16.80 billion in 2023. These investments in content assets were a significant deduction from the operating cash flow. The turnaround in operating cash flow over the past three years can be credited to the company's net profit growth, which exceeded the increase in content asset investments.
Robust financial performance
In the final quarter of 2023, Netflix demonstrated impressive financial performance, with revenue reaching $8.83 billion, a 12.50% increase from the previous year and surpassing analysts' estimates by $120 million.
This growth has been driven by several strategic initiatives. It diversified its pricing plans and introduced advertisement-driven memberships. This led to 70% quarter-over-quarter growth, accounting for 40% of all sign-ups in some markets. Moreover, it successfully monetized account sharing without losing users. As a result, Netflix experienced a steady increase in paid memberships, which grew from 207.64 million at the start of 2021 to 260.28 million by the end of 2023. In the last quarter of the year alone, the global paid members count increased by 13.12 million, with significant growth in the U.S. and Canada. Furthermore, the average revenue per membership increased in most regions.
The company's net income had good growth in the fourth quarter, reaching $981 million, or $2.11 in earnings per share, significantly higher than the earnings of 12 cents per share in the same quarter last year. Its operating cash flow has also improved, reaching $1.66 billion. Netflix anticipates continued growth in the first quarter of 2024, projecting estimated profits of $1.97 billion, or $4.49 per share.
Effective debt management and financial stability
Netflix has consistently managed its leverage effectively. As of December, the company's total stockholders' equity was $20.60 billion, with cash and cash equivalents reaching $7.10 billion. The interest-bearing debt amounted to $14.54 billion. Thus, the net debt settled at $7.44 billion, with a debt-to-equity ratio at a reasonable level of 0.70.
The company has historically maintained its leverage at manageable levels. Its interest coverage ratio, a metric assessing the company's ability to generate enough profit to cover interest expenses on outstanding debt, has always remained at a high level. Notably, while long-term debt has increased substantially from $2.37 billion in 2015 to $14.14 billion in 2023, the interest coverage ratio has shown significant improvement, rising from 1.87 in 2015 to 9.29 in 2023, thanks to the improvement in profitability. Thus, Netflix is in a comfortable position to cover its interest and debt obligations.
Fairly valued
Over the past 15 years, Netflix's Ebitda multiples have fluctuated in a wide range, from 1.62 to 34. Following the 2009 economic downturn, its Ebitda multiples exceeded 20 on two occasions: reaching 20.45 in 2010 and 23.60 in 2018. Currently, its valuation stands at a reasonable multiple of 10.11 times its Ebitda. The present market valuation is only 7% above the 15-year average Ebitda multiple of 10.84, suggesting Netflix's current share price is fairly valued.
Let's use the discounted free cash flow method to value Netflix. We assume the company's free cash flow grows by 20% over the next decade, followed by a 2% growth in the subsequent 10 years. With an 8% discount rate, the estimated share price for Netflix would be $614.56. This figure is only 10% above its current share price, further supporting the conclusion that the stock is currently fairly valued.
Conclusion
The company's global reach, innovative pricing strategies and focus on content have driven a remarkable increase in subscribers and revenue, showcasing its dominance in the streaming industry. With consistent revenue growth, successful monetization strategies like advertisement-driven memberships and account sharing, along with a significant rise in paid memberships, Netflix is expected to outperform in a competitive landscape. The improvement in operating cash flow and net income, alongside effective debt management, further solidifies its financial stability. Netflix's valuation, based on my analysis, aligns closely with its current market price, suggesting the stock is reasonably valued now.
