Netflix Q2 new user additions double expectations, next quarter revenue guidance disappointing, after-hours trading down nearly 7% before rebounding

After the U.S. stock market closed on Thursday, July 18th, streaming giant Netflix announced positive second-quarter results for 2024. However, the stock price fell nearly 7% after hours, mainly due to lower-than-expected revenue guidance for the third quarter, as well as the reality of slowing user growth and a quarter-on-quarter decline in free cash flow.

As Netflix's stock price approached its historical high in November 2021, Wall Street had high expectations for this financial report. Subsequently, Netflix mentioned that there is still significant growth potential in the Indian market, and the stock price stopped falling and turned higher one hour after the financial report was released.

Before the financial report was released, Netflix's stock price opened high on Thursday, but then fell after an initial 1.5% increase to nearly a six-week low, having previously broken through $700 in mid-November 2021 to reach a new high. The stock has risen by 32% this year, outperforming the S&P 500 index by more than 16% during the same period.

Netflix's Second Quarter Revenue and EPS Exceed Expectations, Net User Growth Doubles Market Expectations, but Shows a Seasonal Decline

In the second quarter, Netflix's revenue increased by nearly 17% year-on-year to $9.56 billion, higher than analysts' expectations of $9.53 billion and the company's official guidance of $9.49 billion. In the second quarter of 2023, revenue was $8.19 billion.

Earnings per share (EPS) surged by 48% year-on-year to $4.88, exceeding market expectations of $4.74 and Netflix's guidance of $4.68. In the same period last year, EPS was $3.29.

Operating profit increased by 42% year-on-year to $2.6 billion, higher than market expectations of $2.43 billion. The operating profit margin was 27.2%, higher than the 22.3% from the same period last year, slightly lower than the 28% from the previous quarter but in line with expectations.

At the same time, Netflix's second-quarter net user growth in streaming services exceeded market expectations by nearly double, with the total number of global paid users increasing by 16.5% to approximately 278 million. Analysts expected around 274 million. The net increase in paid streaming media users for the quarter was 8.05 million, compared to the market's expected increase of 4.87 million.

Among them, the net increase in paid users in the largest market of the United States and Canada was 1.45 million, a 24% year-on-year increase, surpassing the market's expected increase of 1.19 million. The Asia-Pacific region saw a net increase of 2.83 million, doubling with a 164% increase, exceeding the expected increase of 1.25 million. The Europe, Middle East, and Africa (EMEA) region saw a net increase of 2.24 million, a 7.8% year-on-year decline but higher than the expected increase of 1.56 million. The Latin American market saw a net increase of 1.53 million, a 25% year-on-year increase.

Some analysts pointed out that North America and Latin America dominated the year-on-year growth in net new paid users, but the quarter-on-quarter growth has slowed down. Although the overall net addition of paid users exceeded the increase of 5.9 million in the same period last year, there is also a trend of quarterly decline. For example, in the fourth quarter of 2023, user additions exceeded expectations by 13.12 million, while in the first quarter of 2024, there were 9.3 million new additions, nearly doubling the expected increase

Netflix will stop reporting new subscriber data and ARPU (average revenue per user) metrics starting in 2025, which has raised concerns about long-term user growth trends. However, the company stated that this is because it will shift its focus from subscriber growth to concentrating on revenue and operating profit margins as the main financial indicators, measuring customer satisfaction through user engagement (i.e. time spent on the platform).

Netflix raises the lower limit of the year-on-year revenue growth rate for the whole year, but the outlook for third-quarter revenue and full-year free cash flow is not optimistic

In terms of performance outlook, Netflix expects full-year revenue in 2024 to grow by 14% to 15% year-on-year, previously expected to grow by 13% to 15%, with the lower limit of the revenue growth range being raised, and the market still expects revenue to grow by about 15%.

Wall Street also expects the annual average revenue growth rate for the next three years to remain at 13%. This year, Netflix's EPS is expected to increase by 53% from $12.03 per share last year to $18.41 per share, and then increase by 21% to $22.29 per share by 2025.

At the same time, Netflix expects the full-year operating profit margin to be 26%, with analysts expecting it to remain unchanged at the level of 25%. Netflix maintains its full-year free cash flow (FCF) expectation at around $6 billion, lower than analysts' expectations of $6.59 billion.

It is worth noting that although Netflix expects third-quarter EPS to be $5.10 per share, higher than the market's expected $4.74 billion, third-quarter revenue is expected to be $9.73 billion, significantly lower than analysts' expected $9.83 billion.

Financial blog Zerohedge stated that Netflix's free cash flow in the second quarter shrank by nearly 50% compared to the previous quarter, dropping to the lowest level since 2022. The company also reiterated that the net increase in subscription users in the third quarter will be lower than the same period last year, which was the first full quarter after cracking down on shared paid accounts.

Netflix is fully committed to expanding its ability to generate revenue from advertising. Currently, it offers a $6.99 per month ad-supported plan in 12 countries/regions worldwide. The company stated that the number of ad-supported subscription plan users in the second quarter increased by 34% year-on-year, accounting for over 45% of all users in the above-mentioned markets, but Netflix also admitted that the road to substantial revenue contribution from advertising is still long:

"We expect that advertising will not be the main driver of revenue growth in 2024 or 2025. The biggest challenge it faces in advertising is the need to provide more products to advertisers and improve technological capabilities."

What is the focus?

Morgan Stanley analyst Benjamin Swinburne stated that despite many positive factors already reflected in Netflix's stock price, considering the significant growth opportunities in the future, he still remains bullish on the stock.

On one hand, investors appreciate Netflix's foray into sports event content and hosting live events. In May of this year, the company announced that it had won the streaming rights for two NFL (National Football League) games on Christmas Day for the next three years.

Netflix's advertising revenue potential continues to be highly regarded. In May, Netflix revealed that its lowest-priced subscription package with ads had garnered 40 million global monthly active users, a significant increase from 15 million users in November last year, an increase of 35 million from the same period last year.

According to sources, since being introduced into the service in 2022, the quarter-over-quarter growth rate of advertising revenue in the last three quarters of last year and the first quarter of this year was as high as 70%, 70%, and 65%, respectively. Goldman Sachs estimates that advertising revenue could generate nearly $3 billion for Netflix in 2024.

In May, Netflix also stated that 40% of all new streaming users chose the $6.99 per month ad-supported package, and plans to launch an in-house advertising technology platform by the end of next year. However, Bank of America believes that advertising will only make a substantial revenue contribution next year.

How does Wall Street view it?

Many analysts raised Netflix's target price before the second-quarter earnings report. Bank of America raised its target price from $700 to $740 to "reflect the continued momentum of the core business," bullish on "world-class brands, leading global user base, and innovative leadership position," and expects that advertising revenue in 2025 and 2026 "will increase significantly (without fear of intense competition)."

Morgan Stanley also shares Bank of America's optimism about Netflix's significant scale advantages in the streaming field, stating that there are still huge opportunities in the future, such as Netflix's share of TV viewing time in more mature markets like North America still being less than 10%, and the company's strong free cash flow generation and robust balance sheet advantages sharply contrasting with competitors who have significantly cut expenses:

"Our analysis of Netflix's user engagement data continues to show its uniqueness, especially in the strength and depth of international content. Strong core execution, efforts to combat password sharing, and ad-supported packages that help penetrate more price-sensitive groups are driving it to achieve its highest net user additions in 2024."

TD Cowen raised its target price to $775 and raised expectations for this year's subscription user growth, stating that Netflix continues to benefit from actions against password sharing. Their survey showed that in the second quarter, 23% of surveyed consumers said they most frequently use Netflix to stream video content on TV, ranking first, with Google's YouTube at 15% in second place, and traditional cable TV at 12% in third place KeyBanc raised its target price to $735 and maintained an "overweight" rating, believing that recent price increases by streaming competitors and Netflix's continued low customer churn rate will support the company's ability to raise prices again in the coming quarters.

J.P. Morgan raised its target price to $750 billion, stating that Netflix's large scale, strong user engagement, and diverse content will make it the default choice for consumer TV, movies, and other long-form content, and will make greater progress in live sports events.

Wedbush Securities, while not changing its target price, maintained an "outperform" rating, stating that the biggest benefit of the ad package is limiting user churn. Netflix continues to strengthen its position as the winner of the "streaming wars":

"Netflix has found the right model through global content creation, cost balance, and increased profitability. We believe the company will continue to expand its profitability and generate more and more free cash flow.

Netflix has successfully established an almost insurmountable leading position in the streaming wars, and we expect competitors to continue to struggle when trying to replicate Netflix's business model."

What to Watch for in the Future?

However, Citibank maintains a cautious "neutral" rating and a lower target price of $660. Morgan Stanley warns that despite the past 18 months, Netflix's significant advertising revenue potential has not been confirmed, and much effort is still needed to expand the advertising scale:

"In addition to competing with Google's YouTube and Amazon Prime Video for advertising clients, Netflix also needs to compete with social media short videos for user time. Artificial intelligence tools may significantly lower the barriers to entry for producing high-quality, professional videos, bringing competition risks."

Stock research firm MoffettNathanson raised its target price to $565 but maintained a "neutral" rating, acknowledging that Netflix has indeed made "significant progress" in combating shared paid accounts. The proportion of users accessing the platform through other people's family accounts has decreased from 15% a year ago when the crackdown began to 9% in the first quarter of this year, but future efforts will become increasingly challenging.

In addition to the trends of adding new subscription users and advertising revenue, the market will also focus on Netflix's plans to open two "Netflix Houses" in Pennsylvania and Texas in 2025, providing immersive experiences that will include "hot IP" merchandise, food, and experiences related to popular series such as "Bridgerton," "Stranger Things," and "Squid Game."

Furthermore, some analysts point out that Netflix's price increase for its ad-free package is aimed at attracting more users to use the ad package. Canceling the cheapest ad-free package in the UK and Canada may also further drive the momentum of advertising development.

There are also analyses suggesting that Netflix's investments in gaming, live streaming, and sports-related content may bring good revenue growth but will impact profits. Netflix is aggressively promoting cheaper ad-inclusive packages, combined with higher digital marketing costs, which may squeeze profit margins