Netflix, Inc.: 3 Compelling Reasons to Consider NFLX Stock

Netflix, IncNetflix, Inc. (NASDAQ:NFLX) is currently one of the most closely followed stocks by analysts. Investor optimism has not wavered, despite the recent mounting of competition by Amazon, Hulu, and Time Warner and a spate of disappointing returns that saw the share price of Netflix stock fall by almost 25% between December 31, 2015 and the end of its second quarter 2016.

Considering its impressive subscriber base, growing customer numbers, rising profit margins, and new content strategy, investors remain bullish in the stocks of the top-rated Internet streaming video company that continues to dominate the market.

Explosive Growth in Netflix Subscribers

Netflix, Inc. is growing at an amazing rate. The company gained 6.74 million new subscribers in first quarter 2016, to close with an impressive 81.5 million subscribers globally. The company entered 130 new markets by January of this year and grew its international new members by 4.51 million in the quarter. (Source: “Netflix Inc (NFLX) Q1 2016 Earnings: Streaming Service Hits 81.5 Million Global Subscribers,” International Business Times, April 18, 2016.)

Just like Amazon.com, Inc. (NASDAQ:AMZN), Netflix has taken the Bezos model, in which the company first undergoes the growth phase, builds a stable customer base, and then profits will follow.

As Netflix adjusts to its international consumer demands, global expansion is poised to be pivotal to its strong growth over the middle term. Benjamin Swinburne of Morgan Stanley reckons that the company hit and exceeded double-digit penetration within three years of debuting in a new market and was already returning a profit. He cited Netflix’s entrance into Brazil as an example where growth was modest in the first few years but has since turned explosive. (Source: “Morgan Stanley: Buy Netflix for these 2 reasons,” Business Insider, June 7, 2016.)

Netflix reported a 22% year-over-year increase in its first-quarter revenue to $1.81 billion, with a sizeable contribution coming from international streaming. Analysts estimate international streaming will account for over 35% of its revenues in the short run and overtake domestic streaming as the major revenue source by 2020. (Source: “The Top 3 Netflix Shareholders (NFLX),” Investopedia, June 7, 2016.)

As more consumers turn to more innovative solutions for their viewing, Netflix’s subscriber base is bound to grow. Several analysts estimate that the company will exceed 100 million subscribers worldwide by the end of 2020. These numbers ought to be taken seriously by any investor. (Source: “Why Netflix is a strong buy even in a depressed market,” Fortune, August 21, 2015.)

Rising Profit Margins

Netflix’s profitability is growing consistently; in the U.S., contribution margin grew from 31.7% of revenue in the first quarter of 2015 to an impressive 35.5% in the first quarter of 2016. The contribution slightly dipped to 34.3% of revenue in the last quarter. Netflix stock, however, remains on course to surpass its year 2020 target of a 40% contribution margin in the U.S. The company also anticipates that in the medium to long run, its international contribution margins will level and, in some cases, surpass its domestic contribution margins. (Source: “Three Reasons to Buy Netflix Now,” The Motley Fool, May 6, 2016.)

Further support for the bullish case for Netflix stock is the increase in the value of each existing subscriber. The company embarked on a rollout of its new pricing and it expects a majority of its subscribers to move from a grandfathered-in price and have the option to continue with the standard definition (SD) plan at $7.99 per month or upgrade to the HD plan at $9.99 per month by the end of its 2016 third quarter.

This will accelerate the growth of the average return per user (ARPU) in the U.S., thus re-accelerating the gross margin expansion in the second half of 2016 and beyond. Moreover, at its pricing for both HD and SD content, the product remains an attractive option for customers since it is less costly than movie tickets or some of the upcoming competitors like HBO, which is currently charging $14.99 per month. (Source: “Will Netflix Continue to Grow in the U.S. and Internationally?Market Realist, July 25, 2016.)

Revamped Content Strategy

In a recent address, Netflix CEO Reed Hastings outlined his company’s objective to improve the overall quality of its catalog. According to trafficking site Allflicks, the company shrunk its video catalog by almost 30% in less than three years; this could be due to the rising prices of streaming rights prompted by increased competition. (Source: “Netflix’s US Catalog Has Shrunk by More Than 2,500 Titles in Less Than 2.5 Years,” Allflicks, March 23, 2016.)

Netflix, Inc. has also refocused on original content and is projected to spend approximately $5.0 billion in content acquisition in 2016. Currently, less than 10% of its content expenditure is spent on original content, and Netflix has made plans to drive this up to 50%. This is expected to strengthen the brand and drive up viewing hours due to rising popularity of original content as well as critical acclaim. This content will generate more revenue as the company explores licensing its content to television networks in international markets. (Source: Market Realist, op cit.)

In a move to drive up consumer satisfaction and retention in the wake of its hiked prices and rising competition, Netflix entered into an exclusive streaming deal with Walt Disney Co (NYSE:DIS), gaining rights to exclusively stream movies from Disney and its affiliates like Marvel, Lucasfilm, and Pixar.

The Bottom Line on Netflix Stock

The bullish story of Netflix, Inc. remains intact. The company is still growing, perhaps not as fast as it was or is anticipated, but growth was still evident and impressive. NFLX stock’s international growth strategy and content enhancement strategy will pay off in the medium and long run.