Netflix Q3 preview: Where next for NFLX stock?

When will Netflix release Q3 earnings?

Netflix is scheduled to release third quarter earnings at 1300 PT on Tuesday October 18. The company is not holding a conference call but will release a video interview with management responding to pre-submitted questions at 1500 PT.

Netflix Q3 earnings consensus

Wall Street forecasts that Netflix will report a 4.5% year-on-year rise in revenue in the third quarter to $7.85 billion and a 28% fall in operating income – its headline measure – to $1.05 billion. Net income at the bottom-line is expected to drop 33% to $957.5 million.

Netflix Q3 earnings preview

It has been an extremely rough ride for Netflix in 2022. Shares have fallen 64% this year to make it one of the worst performing stocks on the tech-heavy Nasdaq 100 after the company started to lose subscribers for the first time in a decade, having shed 1.2 million of them in the first half. That ignited fears that Netflix has already reached its peak, compounded by the fact its biggest rival Disney has continued to grow at a rapid pace – enough so that it has poached the crown from Netflix to become the largest streaming service. 

Netflix has outlined two ways that it plans to reignite user growth. The first is to crackdown on password sharing as people try to avoid paying for its service by using accounts owned by family or friends. This is a big deal – Netflix believes there is over 100 million households skirting its subscription fee. Netflix is using Latin America as its testbed to figure out how to approach the issue, aware that you can enjoy more success with a carrot rather than a stick. It is currently toying with two passive approaches aimed at allowing users to add new users or households to existing accounts.

The second and more ambitious plan is to launch an ad-supported service that will appeal to people that want to watch its content but can’t pay the ever-increasing price tag – demonstrated by the huge numbers that go out of their way to avoid paying the subscription. Markets were wary when this plan was announced considering Netflix had repeatedly shunned the idea and claimed there was no ‘easy money’ to be made by venturing into the competitive world of advertising considering it is dominated by powerful players including Alphabet, Amazon and Meta. However, Disney announced that it was going to launch an ad-supported service back in March, when Netflix said ads did not feature in its plans, and this piled on more pressure.

The company, aware that it doesn’t have anywhere near the level of experience in advertising like its streaming rivals Disney and Amazon, has sought out expertise to drive the launch of the ad-supported service, underpinned by a new partnership with Microsoft. It has also hired new executives from companies that now how advertising works, such as some executives from Snap, the owner of social media platform Snapchat.

The opinion around Netflix’s new ad-supported tier has improved in recent weeks and months as both Wall Street and investors start to the warm to the idea that it could not only revive subscriber growth but improve profitability. Atlantic Equities recently said that the new tier ‘could be extremely material’ and yet to be reflected in consensus estimates, suggesting this could prove to be a major new catalyst when it launches and drive earnings estimates higher. The brokerage sees some risk that existing subscribers will trade-down to the cheaper tier as consumers become more cost-conscious in the tough economic climate but believes the average income it earns off each user can still rise thanks to the lucrative nature of advertising. It estimates Netflix could earn as much as $26 from each user of its ad-supported platform – which would be a stellar result considering it currently earns closer to just $12 from each subscriber to its current service.

We got our first glimpse of what to expect from the service this week. Netflix has announced it will be launching the new ad-supported tier in 12 countries in early November – much earlier than planned considering it had originally targeted a launch in 2023. It will cost around $6.99 per month, some $3 less than its cheapest ad-free tier. Viewers can expect to see four to five minutes of ads for each hour of content, although up to 10% of Netflix’s programmes will be unavailable due to licensing restrictions.

We haven’t had any projections for the service yet, but we could get more details on Tuesday. Chief operating officer Greg Peters declined to provide a goal in terms of subscribers or revenue, although Reuters reported he did nod toward a recent Wall Street Journal report that said it wanted to have 13.3 million ad-supported subscribers on its books in the US by the third quarter of 2023. That same report said Netflix is aiming to have 40 million users on its ad-supported tier globally by the same deadline (although this will be a different metric to include entire households rather than individuals) and Atlantic Equities believes the service could add $6.7 billion in revenue within the first three years of being launched. UBS said it could boost Netflix’s revenue by as much as 10% in the coming years.

The new tier will not make an impact in the third quarter - so, what should we expect when it reports? Well, Netflix has said it is aiming to add one million subscribers on a net basis, which would put it on course to end August with 222.5 million of them on its books. It is expected to continue to lose subscribers in its largest market of North America but counter this with strong growth overseas, particularly in Asia.

That will recoup most of the subscribers lost in the first half and allow Netflix to reclaim the crown as the largest streaming service, although only briefly as Disney will take it back when it reports its next set of quarterly results in November considering it is still growing user numbers at an impressive rate.

Netflix’s revenue is expected to grow 4.5% in the third quarter, but it is important to flag that this will be much stronger at 12% when measured at constant currency. There have been consequences for big multinational US companies from the fact the US dollar has strengthened against all currencies this year and hit multi-decade highs. Netflix earns over 60% of its revenue outside of the US, which means forex markets are currently weighing on its topline.

This is also feeding through to operating profit considering virtually all of Netflix’s costs are dollar-denominated. Operating income is expected to be down 29% in the third quarter, but just 3% lower at constant currency – demonstrating the severity of the impact. Its operating margin is forecast to be squeezed to just 15.9% this quarter from 19.8% in the second and 23.5% a year ago. Rising costs are also hitting profitability, with quarterly operating expenses expected to be over 20% higher than last year.

This could also threaten Netflix’s guidance to deliver an operating margin of 19% to 20% over the full year. Wall Street believes Netflix will need to downgrade this and forecasts it will only be able to deliver a margin of around 17% to 18% in 2022. Analysts also doubt that Netflix can deliver its annual free cashflow target of over $1 billion this year and estimate this will come in closer to $866 million. However, analysts feel confident cashflow will surge to an all-time record of $2.0 billion in 2023.

As usual, the outlook will prove highly influential on how markets react to the update as this will set the tone as markets start to turn their attention to 2023. The launch of its ad-supported tier in November will heighten the pressure for the current quarter. Currently, Wall Street expects Netflix to add 4.1 million net subscribers in the fourth quarter. However, forex headwinds and other pressures means they expect revenue growth to slow further to just 3.7% and for its margin to be squeezed to just 9.4% in the final three months of 2022, which could place profitability further under the spotlight.

Where next for NFLX stock?

Netflix has been the worst performer in the Nasdaq 100 in 2022, but it has significantly outperformed the wider market over the past three months.

The stock has traded within a narrow band during the last three months, drifting between a ceiling of $249 and a floor of $214. Shares are currently testing the bottom-end of that range, which is aligned with the 100-day moving average, and risk opening the door to a fall, first toward $204 and then $170. A fall below here brings $162.70 back into play, marking the four-and-a-half year lows we saw back in May.

On the upside, a break above the $249 ceiling could prove significant and pave the way for a jump toward $333 to close the large gap created last April. The pandemic-induced low that we saw back in March 2020 of $300 can be seen as an interim target. However, brokers believe this could be a challenge considering the average target price sits 14% above current levels at $244.70.

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