Are Netflix (NFLX) Shares Too Expensive Right Now?

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The popular streaming service Netflix is gaining more subscribers than ever. The media giant currently has about 149 million subscribers worldwide. According to Credit Suisse, it calculates that the stock market is embedding an 8% long term sales growth on the company. This basically implies that NFLX will achieve a total of 335 million subscribers in the next decade. Year to date, NFLX stock is up 34%. Things are looking good for the media services provider headquartered in Los Gatos, California. However there is just one major challenge the company has. It’s burning through staggering amounts of cash.

In order to win the streaming war against competitors like Amazon.com and Disney, Netflix has decided to invest heavily into its own blockbuster hits such as Ozark and The Crown series, which cost an estimated $120 million. Netflix announced that its 2018 horror movie starring Sandra Bullock, Bird Box, made a record debut for the business. In the first week of release more than 45 million accounts watched the movie. An account could serve a single person, or an entire family. Since viewers may have watched Bird Box with friends or family, it’s very likely that the total view count by individuals is higher. But to pay for Hollywood A-list actors and expensive production, Netflix had to burn through a lot of money last year. In the last quarter of 2018 negative free cash flow hit $1.3 billion, more than twice the amount from the previous year’s 4th quarter. And this year in 2019, Netflix expects to burn through an additional $3 billion to fund more high quality content. In fact over the past 4 years, the company’s combined negative free cashflow is $7.6 billion, and is getting bigger every quarter.

Of course this type of spending activity can’t go on forever. Neil Begley, Moody’s senior vice president, told CNN Business that, “Netflix is doing all the right things. But they’ve layered over that a level of financial risk that would make a lot of people uncomfortable.” Increasing negative cashflow leads to another problem; increasing debt. Netflix has been borrowing money to fund its projects. Its long term debt obligations have ballooned to $10.4 billion, which is 4 times as much as back in 2015. “All of this growth and investment in content has really been borne by bondholders,” said Begley. “And they plan to continue to do that.”

Since NFLX is trading at roughly 88 times 2019 earnings, it is currently too expensive to recommend at this time. The high valuation does match the historical growth rate of the business. But that’s assuming Netflix can execute on its growth plan flawlessly. If the company hits any snags or delays then the share price would fall. The issue is it’s very difficult for a company to not make any mistakes. Greg Newman of Scotia Wealth gave his outlook on Netflix, saying that although the stock is expensive now, “on weakness, [he] does like it, and [he] thinks you can own some.” And I have to agree with him.

Netflix probably does have a very bright future for investors in the long run. Its subscriber base is growing rapidly. Rather than competing in the broadband internet space in households, Netflix is focusing on wireless accessibility and consumers who use smart phones. There will be hundreds of millions of new people in emerging markets who will have access to mobile devices over the next 10 years or so, and Netflix can take advantage of that. But in the meantime, the short term outlook appears to be too expensive. I would wait for a pullback of maybe 10% or more before buying some NFLX to hold.

This author holds 10 shares of NFLX as of writing this post. He bought the shares back in 2015.

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