Netflix's Q2 Performance is Strong, but Market Concerns Persist

As a global leader in streaming services, Netflix derives the majority of its revenue from user subscriptions. Therefore, the number of subscribers and the Average Revenue per Membership (ARM) are crucial metrics for assessing Netflix's performance growth, and they serve as key dimensions for analyzing Netflix's Q2 2024 results.

The company's revenue growth this quarter continued to be primarily driven by an increase in the number of subscription users. In Q2 2024, the company's revenue increased by 16.8% year-over-year to $9.56 billion, including 8.05 million new subscription users, significantly surpassing Bloomberg's consensus estimate of 4.702 million. The total number of subscription users reached approximately 278 million, up 16.5% YoY. Aside from the number of subscription users, the Average Revenue per Paying User (ARPU) per month did not change significantly; therefore, the company's performance this quarter was still driven by user growth.

Figure: Net Increase in Subscription Users from Q3 2019 to Q2 2024 (in thousands)

Source: Company website

The growth in the number of subscription users was primarily driven by an increase in the number of users opting for advertising bundles. Since 2023, Netflix's resurgence in the growth of new subscription users has been mainly attributed to two key factors: the crackdown on account sharing and the introduction of a low-priced advertising bundle. Over time, the conversion rate of existing shared accounts has continued to improve, and the impact of the shared account policy crackdown has started to diminish. Meanwhile, the appeal of the low-priced advertising bundle to new users continues to strengthen, especially under the conditions of inflation and high-interest rates in the United States, driving the increase in new users for the second quarter. According to the company's disclosure, the number of advertising members increased by 34% quarter-over-quarter in the second quarter. Furthermore, according to data disclosed by the company in May, the Monthly Active Users (MAU) for the subscription service including advertisements reached approximately 40 million, nearly doubling from 230,000 in January 2024.

Looking at the growth by region, the Asia-Pacific area contributed the most new users. In Q2 2024, the North American market saw a net increase of 1.45 million paying users, a 24% increase year-over-year; the Asia-Pacific region saw a net increase of 2.83 million, a 164% increase; the Europe, Middle East, and Africa (EMEA) region saw a net increase of 2.24 million, a 7.8% decline year-over-year; the Latin American market saw a net increase of 1.53 million, a 25% increase. The penetration rate in the Asia-Pacific region is relatively low, and by increasing the production of local content, the company hopes to improve the penetration rate in this region. Countries like Japan, Indonesia, and India are expected to become major contributors to the growth of new users.

In Q2 2024, the company's ARM (Average Revenue per Member) increased approximately 1% year-over-year, remaining relatively stable but falling short of Bloomberg's consensus expectations.

Figure: Change in ARM from Q3 2019 to Q2 2024 (in USD)

Source: Company website

The company's ARM growth primarily stemmed from an increase in membership pricing and advertising revenue. In terms of membership pricing, although the company has implemented price hikes ranging from 11% to 22% in certain countries and regions since Q4 2023, the fact that new users are mainly purchasing low-priced advertising packages has offset the ARM growth that would have resulted from the price increases.

Currently, as the advertising business has yet to achieve significant revenue growth, it is challenging for the company to increase its ARM. According to disclosures by the company's management, in markets where advertising tiers are available, the proportion of users choosing the advertising tier has reached 45%, up 5 percentage points from the previous quarter. However, the ability to monetize advertisements has not kept pace, and thus, advertising revenue has not seen a significant increase, nor has there been a rise in ARM.

Benefiting from excellent cost control, the company's operating profit and net profit both achieved significant year-over-year increases of 42.47% and 44.35%, respectively, this quarter. Additionally, the company has raised its full-year earnings guidance, expecting a 14%-15% year-over-year increase in revenue for 2024, with a projected operating profit margin of 26%.

Netflix continues to maintain a strong competitive advantage in the streaming industry. According to the latest market share data, the company's viewership share reached a historic high of 8.4% this quarter, second only to YouTube. The two operate in different sub-sectors, with other competitors lagging far behind.

However, to maintain its content competitive edge, Netflix must increase its investment in series production and operational services, including planning for offline physical entertainment stores, which poses a challenge to the company's capital expenditures and cash flow. Due to increased content spending, the company's free cash flow declined by 9.46% year-over-year this quarter. It is projected that the full-year free cash flow will remain at $6 billion, below market expectations of $6.59 billion, raising market concerns.

Figure: Company Free Cash Flow from Q3 2019 to Q2 2024 (in millions)

Source: Company website

Netflix continues to possess a strong competitive edge in the streaming industry. It is anticipated that in the fiscal year 2024, with the support of the advertising package and crackdown on shared accounts, the number of paid subscribers will keep growing, although the pace may slow down. Since advertising revenue is unlikely to see significant growth in fiscal years 2024 and 2025, the company cannot rely on an increase in Average Revenue per Member (ARM) in the short term and must instead depend on the growth of paying users, making the growth drivers relatively singular.

Netflix's revenue growth rate is projected to be 14%-15% for fiscal year 2024, with a gradual slowdown expected in fiscal years 2025 and 2026. Despite the company's ongoing optimization of content costs and operating expenses, profit margins are expected to continue to improve, with earnings per share (EPS) anticipated to achieve high double-digit growth in FY24, potentially slowing down in FY25 and FY26. Therefore, FY24 will likely be the peak of the company's growth rate and the highest point of its growth potential. After the peak, a more cautious evaluation of the company's long-term growth potential is necessary.

Regarding shareholder returns, given the sizable content cost expenditures faced by the company and the limited cash on hand, as well as the year-over-year decline in free cash flow, Netflix's share repurchase activities may be difficult to sustain. The company's stock price growth primarily depends on the rapid increase in performance.

Overall, Netflix's growth momentum is singular, and its high growth rate may be difficult to sustain. The company will need to wait for its advertising business to scale up to drive new growth. The market currently holds high expectations for the company's full-year performance in 2024, and the valuation is on the higher side of reasonable, limiting the short-term upside potential for the stock price.

It is recommended that investors holding Netflix shares consider using a covered call investment strategy to secure profits and reduce losses; investors who do not hold the stock may wait for a price correction and seize the opportunity to invest.

Through the above analysis, we can better understand Netflix's performance in the streaming industry and the potential of its future stock price. Whether for existing shareholders or potential investors, decisions should be made wisely in accordance with one's investment strategy and risk preference.