Is misfiring Netflix now a value stock?

Streaming service Netflix said earlier this month that it had lost 200,000 subscribers in the first quarter of 2022. The news sent the company’s share price tumbling by almost 40%.

The US company was one of the main beneficiaries of the Covid-19 pandemic, as lockdowns forced people to stay at home. However, as pandemic restrictions lift and people return to more normal patterns of behaviour, many consumers may question their need to pay for such services.

Another factor could be the cost-of-living crisis, which has been exacerbated by Russia’s invasion of Ukraine. This may be prompting consumers to cut back on non-essential spending.

And some recent media reports have suggested that Netflix subscribers are unhappy at the cancellation of some of the company’s shows, and recent price rises.

Can Netflix’s subscriber numbers recover?

So, is the fall in subscriber numbers a natural part of the business cycle, particularly during a period of rising inflation and higher living costs, or is this something more structural? We asked some of our investment experts.

Michael White, Global Sector Specialist – Consumer, said: “Historically, recessionary periods have not hindered consumers’ desire to pay for video; in 2008, Comcast grew its pay TV revenues by 6%. However, in the world of streaming we are entering unchartered territory, having not experienced a consumer income squeeze before. Netflix did grow revenues in 2008, but this was from a low base as it was the only game in town at the time.

“On the one hand, streaming services are more susceptible to churn than traditional pay TV, given the relative ease of cancelling the service. On the other, times of financial pressure can often induce change, making consumers focus on what they really value. As such, perhaps short-term pain for streaming services may develop into further market share gain from more expensive traditional pay TV services.

“From a structural perspective, the slowdown in subscriber growth could also be interpreted as Netflix reaching a ceiling in terms of market penetration. These fears may be warranted in developed markets such as the US, where Netflix’s reach is likely >90% of pay TV households (when including password-sharing). That said, globally the opportunity remains the 700 million-800 million households that currently pay for video.

“Looking more positively, the potential addressable market could expand to over one billion if we look at households with broadband; this is an internet product after all. For context, Netflix most recently reported c.220 million subscribers.”

Is Netflix now a value stock?

Netflix is part of a cohort of fast-growing stocks whose strong share price performance in recent years has helped power equity returns, particularly in the US.

Until recently, investors have been willing to pay ever-higher prices for companies who appear to be growing quickly. However, the downturn in Netflix’s fortunes has seen its valuation decline, as the chart below shows.

Its price-to-earnings (P/E) ratio (current share price divided by expectations for earnings in the next 12 months) has declined rapidly since the start of this year. It now isn’t all that far above the P/E for the MSCI USA Value index.

Duncan Lamont, Head of Strategic Research at Schroders, said: “This is a good example that shows ‘value’ and ‘growth’ are fluid categories. Companies switch sides all the time. It’s one reason why historical relationships between value and growth, and things like interest rates or the economic cycle, are not stable.

“Sometimes value has had more of a bias to defensive stocks, which are resilient even in tougher economic times. Sometimes the bias is to cyclicals, which tend to be more sensitive to the economic environment. Markets are constantly evolving.”

So could Netflix, or other growth stocks, eventually pique the interest of value investors? Value investors look for companies on cheap valuation metrics, typically low multiples of their profits or assets, for reasons which are not justified over the longer term.

Nick Kirrage, co-head of the Schroders Global Value team, said “Areas of the market that have the biggest chance of falling in value are those that are the most expensive. In recent years the most expensive areas have included some of the disruptive, fast-growing sectors like technology.

“There are some phenomenal tech businesses out there, and the time will come when value investors like me will have the chance to buy them. It’s just a matter of being patient.

“There’s a misconception that value investors are always looking in poor quality or unexciting parts of the market. In fact, sectors like pharmaceuticals or consumer staples – which are typically now regarded as high quality, with strong balance sheets and robust cash flows – have in the past been regarded as value sectors.

“Similarly, while the tech and internet stocks have been regarded as ‘growth’ in recent years, it doesn’t mean this will always be the case.”

Demand for high quality TV will persist

Beyond debates over growth and value, or the fortunes of individual companies, what does look certain is that TV-watching habits are unlikely to change.

Michael White said: “There are two things that we know for sure. Firstly, content is king. A recent study by Kantar showed that, while cancellations were on the rise, Netflix and Amazon Prime Video subscriptions were being prioritised over more nascent offerings with less content, such as Discovery+ or Apply TV+.

“Secondly, consumers still want to watch TV. Even excluding the Covid-induced binge, TV viewing averaged 5.3 hours per day in the US between 2010-2019 with very little variation. This suggests the demand for high quality TV shows and films will long live on.”

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