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Netflix's Growth Is Stalling, but That's OK

Investors found reasons to change the channel on Netflix (NASDAQ: NFLX) this past week. While the streaming-video leader beat its Q2 growth forecast, share prices fell on worries that the business won't bounce right back following the pandemic-related slowdown that's hurt subscription rates in 2021.

Never mind that Netflix is on pace to add nearly 30 million new members in the past year while boosting profitability. Wall Street wanted more.

In a conference call with analysts, co-CEOs Ted Sarandos and Reed Hastings explained why they believe the business is stronger than ever, with growth likely to accelerate in late 2021. Let's look at a few highlights from that presentation.

Image source: Getty Images.

The slowdown isn't a worry

Assuming Netflix achieves its Q3 outlook, the company will have gained just 9 million new global subscribers through the first nine months of 2021. That's a dramatic slowdown compared with the 28 million it gained over the same period last year.

Executives tried to add context to that metric by explaining that the company is on pace to add 54 million new users in the two years that end in late September, or roughly the same 27 million annual growth pace Netflix had established before the pandemic struck. "The growth pattern in our business is, over the long term, remarkably consistent and steady," Sarandos said.

Hastings added that executives don't believe that competition from Disney (NYSE: DIS) and others is harming growth. Churn is low and engagement is up, in fact. So the big-picture growth potential is as bright as ever.

Getting back to normal

Netflix is still eager to get past what executives think is a temporary growth hangover that's impacting the first three quarters of 2021. That rebound should start around Q4 with help from a surge of new TV show and film releases, plus a likely return to more normal TV viewing patterns following a post-pandemic slowdown.

It should also help that the holiday quarter is usually a seasonal winner for the company compared to slower summer months. "We'd expect to end the year on a much more [...] normalized growth trajectory," CFO Spencer Neumann said. But investors will have to wait until Netflix's official Q4 outlook before having a good idea of what that return toward normal might look like.

Cash problems

Netflix's financial wins are still a big part of the bullish investment thesis. Profitability is on track to rise by another 2 percentage points this year, putting operating income at 20% of sales, compared with 10% of sales just three years earlier.

Cash flow should still reach break-even this year before steadily marching into positive territory for the foreseeable future. Those wins are giving management flexibility to invest aggressively into the business while considering other uses for cash like mergers and dividend payments.

But for now, stock buybacks are executives' preferred avenue for cash returns. Netflix started repurchasing stock for the first time in Q2, spending $500 million on shares at an average price of $500 per share.

If management is right about the positive long-term business trends, which should show up more clearly by late 2021, then investors can expect to see much higher cash returns over time.

But first the company needs to return to its prior growth rate following an expected 16% increase in Q3. "The big prize is keeping revenue growth at 20%," Hastings said. We'll find out in three months whether Netflix believes it can break back into that expansion level by Q4.

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Demitri Kalogeropoulos owns shares of Netflix and Walt Disney. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool has a disclosure policy.


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