Netflix is a tremendously risky stock, Gordon Reid says

Netflix’s (NASDAQ:NFLX) subscriber miss has been the talk of the street since the company released its quarterly financials on Monday, but there’s more to worry about than Netflix’s subscription growth, says money manager Gordon Reid, who argues that cash flow is the real issue.

Netflix’s Q2 arrived on Monday with respectable numbers on earnings and revenue. Total revenue was $3.91 billion, up 40 per cent from second quarter 2017, while its earnings per share were $0.85, actually beating the consensus estimate of $0.79. (All figures in US dollars.)

But Netflix posted significant misses on subscriber additions, both domestically and internationally, adding 670,000 new subscribers in the US compared to analysts’ expectations of 1.19 million and 4.47 million abroad versus the consensus 4.97 million.

Netflix management accounted for the difference by saying that it had “over-forecasted” the pace of new subscribers, while the company’s stock initially dropped 14 per cent on the news (but quickly recovered a healthy chunk of those losses in Tuesday’s trading).

One of the market’s top performers in 2018, NFLX is currently up 94 per cent for the year. But while subscriber growth is a genuine concern for the streaming content provider, they’ve got a thornier issue in their cash flow, says Reid, CEO of Goodreid Investment Counsel.

“They missed in terms of growth of subscribers by about a million, which is big because it was on a base of about five million,” Reid told BNN Bloomberg yesterday. “To me, that missed the point. This is a company that although on an earnings level it’s quite respectable, on a cash level they’re not.”

“Anybody who’s in the business of analyzing companies knows that you have to get as close to cash as possible because a great many games happen in-between and what is happening at Netflix is that they are amortizing their costs of producing shows, buying shows, which is in the billions of dollars, over a great many years,” he says. “Yet, they’re recognizing the subscription revenue right up front. So, this is a company that is cash-challenged.”

In its earnings report, Netflix said it had spent $559 million in cash over Q2, modestly lower than the $608 million it spent during Q2 of 2017. Bloomberg estimates that the company will spend $8 billion on its original series in 2018, which is $1 billion more than management projected.

“I’d say that if you take it to the fullest extent, there’s a tremendous amount of risk here,” says Reid. “This isn’t about growth of subscriptions. They’re getting those. One shouldn’t worry about whether they miss it one quarter or not. Subscriptions are very, very correlated to new offerings, so the new programming that comes to the market, second quarter they were a little lighter on new programming, they’re a little light on subscriptions. So, people drove the stock down but for the wrong reason.”