Netflix Inc. (NFLX, Financial) will report its first-quarter results on April 18. Analysts are expecting higher membership and revenue numbers. In fact, the company's management projected 13.20% revenue growth year over year compared to 2023.
If it meets thise targets, free cash flow growth and margins could push the stock up by 20% to 28% over the next year.
Membership and revenue growth
Netflix had strong streaming membership growth in the fourth quarter of 2023, recording over 260 million streaming members, up 5.30% quarter over quarter and 12.80% year over year.
Moreover, its revenue was strong at $136.50 per member. This can be seen in the chart below, along with revenue and membership forecasts.
Revenue is expected to keep growing strong due to higher membership numbers and from its efforts to earn advertising dollars.
For example, in the third quarter of 2023, its ads membership increased nearly 70% quarter over quarter. Netflix still does not break out ad revenue from its membership revenue. However, the shareholder letter said ad members represent about 30% of all new sign-ups in the 12 counties where it offers them (i.e., at a lower monthly price). But by the fourth quarter, its ads members accounted for 40% of all new signups in the markets where it is offered.
In its fourth-quarter shareholder letter, management projected that its ads business would start to contribute significantly to revenue growth starting in 2025.
The bottom line is that analysts now expect revenue will rise from $33.70 billion in 2023 to $38.60 billion this year, up 14.40%. This is higher than the Netflix management forecast of 13.20% year over year growth for the first quarter. But that growth includes a 3% decline due to Argentine peso devaluation. Net of that it would be over 16% in the quarter and possibly the whole year, although analysts have a lower 2024 growth rate of 14.40%.
Moreover, in 2025, the average sell-side analyst revenue forecast is $43.20 billion, up 12% over 2024.
This will likely lead to significant growth in the company's free cash flow and FCF margins going forward. That could push Netflix's stock significantly higher.
Free cash flow and FCF margins
Last quarter Netflix generated $6.93 billion in free cash flow in the trailing 12 months on revenues of $33.70 billion. That means its trailing 12-month FCF margin was high at 20.5%.
Its free cash flow margins have been growing consistently. The chart below shows its quarterly FCF margins have risen by roughly 3 percentage points in the last several quarters, from 9.10% in the first quarter of 2023 to 20.30% in the fourth quarter of 2023.
This leads to a projection that in 2024 its FCF margins could rise to 24% of revenue. That assumes that over the next three quarters, the growth in margins slows to just 1% a quarter from 3% a quarter on a trailing 12-month basis.
Keep in mind this includes higher capital expenditure spending by Netflix on movie production. For example, last quarter the company spent 1% of sales on capex, or $350 million.
It also expenses all ongoing movie production costs during any particular year. Going forward, we estimate slightly lower capex-sales ratios, but still close to 1%.
The table above shows I expect the company's operating cash flow margins will rise to 25% this year and next. It also shows that capex spending will rise to $380 million and $420 million this year and next (or 0.98% of sales).
The net result is $9.26 billion in FCF this year, up over one-third from the $6.93 billion it made during 2023. And next year investors can expect to see FCF rise by over 12% to $10.38 billion.
Price targets
This will bring significant upward pressure on the stock. For example, one way to value Netflix is to theoretically assume the company will pay out all of its FCF as a dividend to shareholders.
This is even though Netflix still does not pay a dividend. But it certainly now has the FCF to afford to pay one. So it's not out of the realm of possibility that this could happen.
If this were to happen, it might lead to at least a 3% dividend yield for the stock. Here is how I came up with that valuation.
A similar company, The Walt Disney Co. (DIS), is now paying a semi-annual dividend per share of 45 cents for a dividend yield of 0.789% (i.e., 90 cents/$114.01 per share). This will cost Disney only about $1.65 billion annually, or 20.8% of its $7.94 billion in FCF.
That means a 100% dividend payout would be 4.80 times higher. This implies that Disney's stock would have a 4.80 times higher yield than 0.789% if it paid out 100% of its FCF in dividends (it is actually going to spend $3 billion on buybacks instead). That raised with a 100% payout, its dividend yield would be 4.80 times higher than its present 0.789% dividend yield, or 3.78%.
Since Netflix has a higher quality of earnings, at least in terms of its predictability, and consistency, the stock would likely have a better dividend yield. That is why I used a 3% FCF yield metric to value the stock. Here is how that works out:
The table above shows that using a 3% yield, or 33.30 times FCF, Netflix is worth from $309 billion to up to $346 billion by the end of next year. That puts it the value of the stock up to $800 per share by the end of next year.
Keep in mind this assumes the company continues to show strong membership and ads revenue growth, along with strong operating and free cash flow margin growth. If the company's results come in later this month strong as expected, the stock is likely to begin to show this upside potential.
Moreover, this does not take into account lower share counts from the company's ongoing $2.50 billion share buyback program. For example, in fourth-quater 2023, there were 7.30 million lower at 444.30 million shares outstanding. That represents a 1.60% share count reduction.
As a result, its earnings per share and eventual dividend per share could be higher than it would be otherwise. That helps increase the stock's valuation as well. The bottom line is Netflix's stock looks undervalued and its strong free cash flow and buybacks can lead to a significantly higher stock price.
