Shares of streaming giant Netflix (NASDAQ: NFLX) are trading at $488 which means it has lost over 10% in market cap following its third-quarter results. Netflix announced its Q3 results on October 20 and reported sales of $6.44 billion with earnings per share of $1.74.
Comparatively, analysts expected the company to post sales of $6.38 billion and earnings of $2.13 in the September quarter. While Netflix beat Wall Street estimates, its lower than expected earnings dragged the stock lower by 10%.
Netflix forecast sales of $6.57 billion with EPS of $1.35 in Q4. Analysts tracking the stock forecast sales of $6.58 billion and EPS of $0.94.
What drove Netflix sales in Q3
The company added 2.2 million paid subscribers in Q3, significantly lower than the 6.8 million subscribers in the prior-year period. However, the total subscription additions for Netflix was 28.1 million in the first nine months of 2020 which is already higher than the 27.8 million figures for the whole of 2020.
Netflix said, “We added 2.2m net memberships in Q3, compared with our 2.5m guidance. Retention remains healthy and engagement per member household was up solidly year over year in Q3'20."
In Q4, Netflix forecasts to add six million subscribers compared to 8.8 million in Q4 of 2019. The company had warned that the acceleration of paid subscribers in the first half of the year will result in a slowdown in its subsequent quarters.
Despite this slowdown, Netflix expects to end 2020 with 34 million net additions, 19% higher than the record net additions of 28.6 million in 2018.
Netflix clarified, “The state of the pandemic and its impact continues to make projections very uncertain, but as the world hopefully recovers in 2021, we would expect that our growth will revert back to levels similar to pre-COVID. In turn, we expect paid net adds are likely to be down year over year in the first half of 2021 as compared to the big spike in paid net adds we experienced in the first half of 2020.”
What next for investors?
The revenue growth has allowed Netflix to improve bottom-line at a rapid pace. Netflix has forecast operating margin of 18% in 2020, up from just 13% in 2019. It has quadrupled its GAAP operating margin since 2016 and expects to improve operating margin by 300 basis points annually going forward.
Netflix’s year-to-date cash flow stood at $2.2 billion which was higher than the $1.6 billion figure in the first nine months of 2019. However, as the company continues to increase its production, it expects Q4 free cash flow to be negative and end 2020 with $2 billion in FCF.
As production spending gains pace in 2021, Netflix forecasts FCF to be between negative $1 billion and break-even next year.
Investors need to take advantage of the recent pullback in Netflix stock and buy the stock at a lower valuation. Netflix continues to remain a market leader in the streaming space and has significant potential to grow in international markets of Asia, Latin America and Europe.
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