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Netflix's Q2 results to clarify post-pandemic growth prospects

When Netflix Inc. reports its second-quarter earnings results on July 20, the company may have to prove it can merit its growth-company valuation.

The first half of 2021 was not particularly kind to the streaming giant, despite significant gains made during the pandemic in 2020. Executives' prediction of a pull-forward in membership growth proved to be accurate. After a notable miss in paid new member additions during the first quarter, the company kept guidance at a modest 1 million paid net additions for the second quarter. Analysts are affirming that slow growth figure and setting their sights ahead to determine whether Netflix can continue to warrant its high price.

Analyst Matthew Thornton of Truist Securities remains one of Netflix's bull commentators, arguing for a $600 price target and a "buy" rating for the company. Netflix shares closed July 16 at $530.31.

While Thornton sees limited upside to Netflix's 1 million subscriber guidance, he still believes investor expectations are "subdued," leaving money on the table for the streamer.

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The company's stock added only 4.7% in the year ended July 14, compared to a gain of 50.8% for the S&P BMI Media & Entertainment Index, and Thornton sees upside in Netflix's improved content slate in the second half of the year and its impending repurchase program.

Year-over-year comparisons also seem to be favorable on several metrics. Second-quarter 2020 EPS was $1.59, well above the 2019 figure but well below the $3.75 per share Netflix generated in the first quarter of 2021. The second-quarter 2020 membership growth of 10.1 million paid net additions is about 10x the company's guidance for the just-completed quarter, but the comparison in third quarter 2020 gets much easier at 2.2 million, just as Netflix's content slate is poised to begin ramping back up, Thornton argues.

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Further, Thornton believes Netflix's move into new lines of business, like merchandising and gaming, can improve its long-term prospects by expanding its total addressable market. The company's stock reacted favorably to recent news that it is building out a gaming unit.

However, not all analysts believe gaming will be the rung Netflix needs to continue up the growth ladder. MoffettNathanson analyst Michael Nathanson took a critical view of Netflix's new product lines. The company does need a successful "second act" to continue to justify its high valuation, but the analyst believes rather than gaming or merchandise, Netflix should leverage its position among consumers and add advertising and sports programming.

Nathanson in a recent note went on to present a dour view of Netflix's market position, indicating that holes in the company's growth story are becoming evident among investors.

"Despite the acceleration in streaming usage from the COVID-19 pandemic, Netflix has been, at best, a market-performing stock over the past year," Nathanson said. "We believe a combination of factors has limited Netflix's stock performance, such as a maturing U.S. subscriber base, an intensifying competitive environment among streaming services, and a cyclical rotation in the market to value names this year."

A wider lens does not reflect much more kindly on Netflix, as it underperformed the S&P 500 by 23 percentage points since the start of 2018, the analyst pointed out.

He maintained a "neutral" rating on the stock and a $460 price target.

Wedbush Securities analyst Michael Pachter also expressed doubt about Netflix's current valuation. He believes Netflix has a strong first-mover advantage and its overseas growth remains compelling. Despite these opportunities, he still was unable to get anywhere near Netflix's current enterprise value. In a recent note considering the company's second-quarter prospects, Pachter put a $342 price target and "underperform" rating on the ticker.

Pachter modeled for roughly flat growth in North America in the second quarter and believes the company's platform is "approaching market saturation" in the domestic market. North America has been the slowest-growing market over the past eight quarters for Netflix, excluding a big pandemic-related jump in North American paid members in the second quarter 2020.

Further, the growing competition will continue to require Netflix spend more and more of its cash flow on content creation and acquisition, Pachter said, limiting its financial upside.

"While there may be some room for Netflix to add some new high-ARPU subscribers, competition is at its most fierce [domestically], and with over half of all households already penetrated, the 'low hanging fruit' (above median income households) has already been harvested," Pachter said.

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