Netflix kicks off tech’s Q1 earnings season on Thursday, and is setting a high bar after guiding for a first quarter revenue acceleration and nearly double-digit margin expansion. Netflix returned to double-digit growth in Q4, and guided to 13.2% YoY revenue growth, the fastest growth rate since Q4 2021.
We noted in Q4’s post-earnings report that average revenue per member (ARM) would be one of the more important metrics to watch this quarter, after Netflix raised prices for the first time in 18 months last October. Commentary from management implied we would see ARM return to growth in 2024 after being flat to negative throughout 2023.
Despite not yet being a substantial driver of growth, management was optimistic about the ad tier, saying they expect strong growth off a small base this year to transition ads into a “substantial revenue stream” in 2025 and beyond. Netflix has not updated its ad tier subscribers since January, so an update may be in store.
Notably, Netflix has gone through a phenomenal turnaround on the bottom line and this was the primary reason we added the stock to our portfolio about 18 months ago. Earnings continues to grow while cash flow is pausing on growth, per current estimates and commentary. We detail this and more below.
Revenue and EPS:
Netflix guided for $9.24 billion in revenue in Q1, representing YoY growth of 13.2%, with a three percentage point headwind from the devaluation of the Argentine peso relative to the US dollar. On a constant currency basis, this represents approximately 16% YoY growth.
Revenue growth is poised to continue accelerating through Q2, with estimates pointing to 16.3% growth in the June quarter before softening to the 14% range for the back half of the year. Q2 is still expected to mark ‘peak’ growth as was noted in January; however, revenue growth forecasts for 2025 have inched higher. Prior to Q4, revenue growth was projected to moderate to the 10% range, but now it is expected to hover in the 12% range.
Q1’s EPS guide called for more than 112% QoQ growth and 56% YoY growth to $4.49, which would be Netflix’s highest ever quarterly EPS print. Much of this EPS growth stems from margin expansion driving increased operating leverage – Netflix guided for operating income to increase nearly $1 billion sequentially to $2.42 billion, and that is flowing straight through to the bottom line with net income guided to rise by more than $1 billion sequentially to $1.98 billion.
This sets the stage for strong EPS growth for fiscal 2024 and into 2025. Current estimates call for EPS growth of 43.1% YoY to $17.22 in 2024, a strong double-digit acceleration from 20.9% growth in 2023. EPS growth in 2025 is projected to moderate to 23.2% YoY to $21.21.
Margins:
Operating margin expansion is one of the primary highlights for Q1’s upcoming report, with Netflix guiding for a 26.2% operating margin in the quarter, a ~930 bp expansion to the highest level in three years.
An operating margin in the mid to high-20% range is not out of the ordinary for Netflix in the first quarter, with margins in this ballpark in 2021 and 2022. However, Netflix increased its full year operating margin guide from 22.5% at midpoint to 24%, implying that margins through the remainder of the year will remain strong, and not as prone to sequential weakness as we had seen in 2021 and 2022.
Q2’s operating margin guide will provide clues as to how this will unfold – a guide for sequential growth would imply a weaker Q4 in line with historical trends, while a guide in the low 20% range points to steady margins and likely strong YoY expansion in Q4.
With this operating margin strength, net margin in Q1 is also expected to be very strong at 21.4%. This compares to 10.6% in Q4, and 15.9% in the year ago quarter.
Cash Flows and Balance Sheet
Cash flows have been a strong point throughout 2023, with Netflix more than tripling operating and free cash flows and driving more than 1500 bp expansion in operating and free cash flow margins for the full year.
Operating cash flow was $1.66 billion in Q4 and $7.27 billion in 2023, for a margin of 18.8% and 21.6% respectively. The 21.6% margin in 2023 marked a substantial 1520 bp expansion from 6.4% in 2022, as operating cash flow increased 259% YoY. For Q1, operating cash flow is expected to be just north of $2 billion, for a margin of ~22.0%.
Free cash flow was $1.58 billion in Q4 and $6.93 billion in 2023, for a margin of 17.9% and 20.5% respectively. Free cash flow increased 328% YoY last year, though growth is pausing – management guided for ~$6 billion in FCF this year, or a (13.4%) YoY decline with this lumpiness caused by the WGA and SAG-AFTRA strikes.
Netflix has more than $7.1 billion in cash and short term investments on the balance sheet, while debt totaled $14.5 billion.
Key Metrics: ARM, Paid Net Adds In Focus
Paid Adds:
Paid net additions were probably the strongest key metric in Q4’s report. Netflix reported 13.12 million paid net adds globally, driving global paid memberships up 12.8% to more than 260 million. This marked the fourth quarter of accelerating growth and the highest growth rate in eleven quarters for global paid memberships.
Management hinted that we would see strong paid net additions in Q1, saying that “similar to prior years, we expect paid net additions to be down sequentially (reflecting typical seasonality as well as some likely pull forward from our strong Q4’23 performance) but to be up versus Q1’23 paid net adds of 1.8M.” However, this leaves quite a wide range for where paid net adds could fall – Q4’s total paid net adds surpassed 13.1M, so technically, anything between 2M and 13M is fair game and would align with management’s commentary.
Consensus for paid net adds sits on the lower end of the range, at 4.11 million. Analysts from TD Cowen are expecting paid net adds of 5.11 million, noting the firm is “benefiting from a dual tailwind of paid sharing initiatives as well as strong underlying business demand from a robust, increasingly global content slate.” This 5.11 million expectation would correlate to global paid membership growth of almost 14.2%, suggesting analysts are looking for another quarter of acceleration in Q1.
ARM:
ARM also will be watched closely, given that it is expected to inflect back to growth and contribute to revenue growth instead of providing a headwind as it had in 2023. Netflix said for 2024, it expects “healthy double digit revenue growth…on a F/X neutral basis driven by continued membership growth as well as improvement in F/X neutral ARM as we adjust prices.”
As Netflix’s largest region by paid memberships, EMEA’s return to growth in ARM will be critical, given that it declined (1%) YoY to $10.84 in Q4 on an F/X neutral basis. Return to growth in APAC may take an extra quarter of two, given that Netflix has been struggling to improve monetization with ARM declining for seven straight quarters. UCAN ARM accelerated to 3% growth in Q4 from 0% in Q3, and further acceleration will help offset residual weakness in APAC in Q1 and potentially lighter growth in EMEA.
Ads:
With management aiming to make ads a more substantial revenue driver in 2025, updates on ad-tier subscriber count could be in store, following strong growth over the past three quarters and potential for partner deals like that with T-Mobile further boosting growth.
We have seen strong adoption of Netflix’s ad-tiers so far: subscribers tripled from 5 million in May 2023 to 15 million in November, before rising another 53% to 23 million in early January. Ad-tier subscribers now account for nearly 10% of Netflix’s total paid memberships.
In late January, all of T-Mobile's subscribers to its Netflix on Us deal, which previously offered a free Netflix Basic subscription, will convert to Netflix's Standard with Ads tier unless subscribers pay the difference for a plan without ads. Management explained that these kinds of partner deals are “very effective, very useful for us because that lower consumer-facing price means that we got room now to bundle the ads plan into a set of lower-priced partner offerings where it was hard to make the economics work for everyone previously.” This provides two outlets for growth –a surge in ad-tier users from those who do not wish to upgrade, and extra revenue dollars from those that pay the difference to upgrade.
Conclusion
Netflix has been delivering on its promise to shareholders with accelerating revenue and subscriber growth, greatly improved margins and cashflows, and strong EPS growth. A few metrics we are watching closely include ARM and paid net additions growth, given the strong numbers Netflix has reported recently.
We are also on the lookout for whether the ad tier’s strong initial adoption will begin to slow and/or if Netflix will run out of growth levers, though this may become more of a concern for 2025. With that said, an ad tier should greatly improve margins as we go along and that’s also central to the story beyond paid net additions. We will keep you in the loop on how we view Netflix’s peak growth in Q2 and the inevitable slowing growth come 2025 (or perhaps 2026) in the face of its impressive and expanding margins and cash flows.
Damien Robbins, Equity Analyst at the I/O Fund, contributed to this analysis
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