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Netflix Inc (NFLX) reported strong sales and membership figures for Q2 released on July 18. However, its free cash flow (FCF) performance was significantly lower than last quarter's. It implies that NFLX stock could be fully valued. But take another look.
The reality of its valuation is more subtle. If you look at management's FCF guidance and the stock's historical FCF value metrics, there is still hope for bulls.
Today, NFLX stock is down about 1% to $636.52. That gives it a market cap of about $273 billion or so.
Based on my calculations, Netflix could still be worth over $306.4 billion, or 12.2% more and the NFLX price target could be $714 per share over the next year. This article will explain why.
Strong Results and Guidance
Revenue rose 16.8% and operating income was up +42.5%, both Y/Y. However, Netflix's free cash flow (FCF) fell dramatically. Last quarter it was $2.137 billion, but in Q2 it dropped by almost a billion to $1.213 billion. Moreover, compared to last year ($1.339 billion), its Q2 FCF was down by $126 million or 9.4%, despite 16.8% higher sales Y/Y.
That means that the company's FCF margins tumbled as well. For example, last year FCF represented 16.36% of sales but in Q2 2024 it was just 12.69% (i.e., $1.213b/$9.559b in sales).
That's the bad news. The company is spending more heavily on movie production and that could have sort of been predicted, given the end of Covid and writer's union stoppage.
The future outlook is not so bad. For example, management now says it still expects to make at least $6 billion in free cash flow this year. That might be too conservative.
For example, in the first half of 2024, it has already generated $3.349 billion. That represents 17.69% of its $18.929 billion in H1 revenue. Comparing the $6 billion management forecast for 2024 to analyst sales estimates of $38.72 billion in revenue for this year shows that its full-year FCF margin will be at least 15.5%.
So, going forward, the company may generate between 15.5% and 17.7% in FCF margins, or 16.6% on average. We can use that to set a price target for NFLX stock.
Price Target for NFLX Stock
For example, 43 analysts surveyed by Seeking Alpha have a 2025 revenue forecast of $43.37 billion for Netflix. Applying a 16.6% FCF margin to this implies that the company could generate $7.2 billion in FCF going forward.
How will the market value this FCF? One way is to look at its present valuation. For example, based on its $6 billion FCF forecast and the stock's $273 billion market cap, it's trading on an FCF yield of 2.2% (i.e., $6b/$273b = 0.022).
Just to be conservative, let's use a 2.35% valuation metric. That means that if we divide our $7.2 billion 2025 billion FCF forecast by 2.35%, we get an estimated $306.4 billion market valuation. That is 12.2% higher than today's market cap.
In other words, NFLX stock is worth 12.2% more, or $714 per share (i.e. 1.122 x $636.52 = $714.18).
Analysts Have Higher Price Targets
Analysts also have higher price targets for NFLX stock, despite the disappointing results. This reinforces my higher price target for NFLX stock.
For example, Yahoo! Finance, which uses Refinitiv survey data, reports that 38 analysts have an average price of $638.21 per share. Barchart reports that the mean target for analysts if $669.21. These are both higher price targets over today's price of $636.52 per share.
Moreover, AnaChart, a new sell-side tracking service, reports that 35 analysts who have recently written on Netflix have an average price target of $676.80. Moreover, many of these analysts, who have good track records on NFLX stock, have price targets well above $700 per share.
This can be seen in the table above. Note that many of these analysts have Price Targets Met Ratios that are very high (over 90%). That means that over 90% of the time the stock has risen to their price targets. That implies it could happen again.
The bottom line is that NFLX stock still looks cheap here, despite the disappointing FCF performance this quarter. It could be worth as much as $714 over 12% more in the next year. That assumes that it generates at least $7.2 billion in FCF or 16.6% of its projected 2025 revenue.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
