It’s hard to impress investors during this earnings season. Netflix, the streaming giant, reported Q1 earnings on Thursday evening, and even though they reported 9.33mn new subscribers over the quarter, much stronger than the 4.84mn expected, its share price was down more than 3% in after-hours trading.

Subscriber growth crushed estimates, and the other details within the report were strong. Revenue for the quarter was $9.37bn, up 15% vs. Q1 2023, and stronger than the $9.26bn expected by analysts. Earnings per share were $5.28, vs $4.52 expected. Operating income was 54% higher than Q1 2023, at $2.63bn, beating estimates of $2.43bn. Added to this, operating margin, a key measure of profitability, was also higher than estimated at 28.1%, vs. 25.7% expected.

What’s wrong with Netflix’s earnings?

The problem with the earnings report was the Q2 forecast. Netflix has estimated that revenue would come in at $9.49bn, slightly lower than the $9.51bn the market had expected. This is a small discrepancy and back at the start of the year this could have easily been ignored or brushed over. Now, there is too much focus on valuations, profitability and the ability to grow revenues in an uncertain environment for the market to ignore a revenue forecast miss.

Higher interest rates could also boost debt financing costs

There were some other details within the earnings report that might be worrying investors. The company expects subscriber growth to slow in Q2, however this tends to happen historically, and is considered a seasonal malaise, before subscription numbers rise again in the second half of the year. The company still has a hefty debt load of $14bn, and it has boosted its revolving credit facility to $3bn from $1bn. This is a sign that the company wants to invest and grow, yet they are also extending their credit lines at an expensive time, with interest rates poised to potentially stay elevated for the rest of the year. Added to this, there could be concerns about refinancing their current debts at higher interest rates, which could increase their debt financing costs in the coming quarter.

Preparation for leaner times at Netflix?

The company has no plans to buy back stock, which is typically a sweetener for investors, as they value ‘balance sheet flexibility’. While Netflix is currently adding enough subscribers and brining in strong revenues, this suggests that the company is preparing for leaner times, potentially when their crackdown on password sharing does not provide such a favorable uplift to its earnings reports.

Netflix: still the content leader

Looking ahead, the company pledged to improve the variety and quality of its content. As the company grows, it now estimates that half a billion people watch Netflix, it will need to vary its content to tap into new markets and cultural preferences etc. In Q1, its most watched show was Griselda, other successful shows included One Day and The Gentlemen.

The streaming sector is large and made up 38.5% of all American TV viewing in March, of this, Netflix had an 8.1% share. Netflix reported that it had the number one streaming movie for 8 of the first 11 weeks of this year, and the number one original series for 9 of the first 11 weeks of this year. You can see why it is hard for rivals to catch up. Even though Netflix’s stock price is selling off, it still produces a quality product that people want. Also, some of its rivals, including Prime and Paramount are struggling, while the new kid on the block, Peacock, is doing well at winning subscribers but is still in its development phase, so is not a direct threat to Netflix right now.

Netflix: Shifting its focus away from subscriber growth

Netflix also said that it would change how it reports its results from 2025. Quarterly subscriber numbers are out, and instead the company will focus on revenue and operating income, along with EPS, operating margin and free cash flow. This is partly due to growth in multiple revenue streams, not just in subscribers. For example, the advertising business is growing strongly, and is expected to expand in 2025. Whether or not it can make up for the massive growth that has been generated by the password crackdown remains to be seen.

Is Netflix over-valued?

Its share price has had a strong run in the past 6 months, and is higher by more than 50%, although Netflix’s share price has struggled of late, and is down by 2.8% in the past week. Its P/E ratio is more than double that of the overall S&P 500 and is 42.5. Thus, if you want to own Netflix you need to pay up for it.

This is why investors have shrugged off the earnings data: there are cheaper parts of the market, they missed future revenue targets, and their focus on advertising as the next big revenue driver could come when the economy is struggling and entering a cyclical downturn. Investors are looking beyond these figures and towards a future where Netflix is past its peak for subscriber growth and revenues. Thus, unless market sentiment recovers in the near term, we could see Netflix’s share price struggle.

Netflix is seen as the start of tech earnings season, and it is a reminder of the high bar the market has set for Q1 earnings. Reports can generally be stellar, but any weakness in forward guidance is being used as an excuse to sell. 

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