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Netflix Inc (NFLX) stock is down about 8% after releasing excellent earnings yesterday. This makes no sense despite market concerns about its reporting. Shorting OTM puts is attractive for income and a cheaper buy-in.
NFLX stock is trading at about $560 in morning trading on Friday, April 19, after releasing its Q1 results after the market close yesterday. The premier streaming company reported that its paid memberships grew from 260.28 million to 269.60 million in the prior quarter, a Q/Qgain of 3.58% and 16% Y/Y.
Moreover, revenue rose 14.8% Y/Y and 6.08% to $9.37 billion in Q1. In addition, its free cash flow (FCF) jumped 34.67% from the prior quarter from $1.587 billion to $2.137 billion.
Free Cash Flow Matters Not Memberships
However, Netflix said it will no longer provide membership growth forecasts. Starting in 2025 the company will no longer report those numbers (and average revenue per member). The company provided a good explanation. It said its profitability and free cash flow matter more now for the stock than memberships.
Wall Street seems to differ, which is why the stock is down. However, I have consistently pointed out that the company's FCF margins are continuing to expand. That will influence the stock price in the long term more than membership roles.
For example, you can see in the table above that its Q1 FCF margin was 22.8% (i.e., $2.137b FCF/$9.37b revenue). That was higher than the Q4 2023 17.9% FCF margin and the prior quarter as well.
This is largely due to operating leverage. In other words, as revenue rises its operating costs are not rising as fast. That means profitability and FCF is leveraged as incremental sales rise. This could be due to the increasing role that ad revenue is playing with the company, but also good cost controls. For example, its operating margins YTD are 28.2% compared to 20.9% in the full year 2023. In addition, despite more movies available to viewers, including on an exclusive self-developed basis, its capex spending was $5.919 billion lower than the prior quarter.
Price Targets
Analysts project $38.52 billion in revenue this year and 12% higher sales next year at $43.2 billion. That alone could push NFLX stock higher. But if the company can make an average 28% FCF margin next year, its free cash flow could rise to $12.1 billion.
That implies, using a 3% FCF yield metric, that its market cap could rise to $403 billion, up from $247 billion today. That implies NFLX stock could be worth 63% more at $912.80 per share.
But even using a 25% FCF margin (i.e., $10.8 billion in FCF next year), implies NFLX stock could have a $360 billion market cap in a year, or 45.6% higher. That implies the stock is worth at least $815.36 per share.
Other analysts agree. For example, the average price target of 37 analysts according to Yahoo! Finance (I believe this is a Refinitiv database) is $634.58 per share, or 13.3% higher. Moreover, AnaChart.com shows that 39 analysts have an average price of $639.35 per share, or 12.4% more.
The bottom line is that NFLX stock looks cheap here. In case the stock keeps falling, one way to buy in cheaply is to sell short out-of-the-money (OTM) puts in nearby expiry periods.
Shorting OTM Puts
For example, look at the May 3 expiration period, which is 2 weeks away. It shows that the $550 strike price put options trade for $9.40. That provides an immediate yield of 1.709% to the short seller (i.e., $9.40/$550.00).
This means that any investor who secures $55,000 in cash and/or margin with their brokerage firm can enter an order to “Sell to Open” 1 put contract for expiration on May 3 at $550. The account will immediately receive $940.00, i.e., a 1.71% yield.
Moreover, if the stock does not fall to $540.60 by May 3, the investor will have a profit (i.e., $550-$9.40). This provides a good entry buy-in point for disciplined investors. Even if the stock does fall by over 2.2% to $550 and the investor has to buy 100 shares at $550, they know that the long-term outlook is good for the stock. They can then either hold on or sell covered calls to recoup any unrealized losses.
However, the short-put seller runs the risk that the stock will rally by May 3 and they will not be able to buy the shares at the $550 strike price.
The bottom line is that NFLX stock looks cheap here. It makes sense to buy it cheaply here and/or short OTM puts to create extra income.
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.
