Churn, Baby Churn? As Netflix Prepares To Report Q3 Earnings, Analysts Eyeing Subscription, Cancellation Counts

It seemed as though Wall Street analysts were tripping over each other last week racing to upgrade Netflix Inc NFLX shares ahead of Tuesday’s earnings report.

Yes, the streaming video giant appears to have Wall Street excited as millions of subscribers remain stuck at home and in need of entertainment to bring a little joy into their lives as the holiday season approaches.

NFLX has risen to the challenge, speedily rolling out new releases—74 are on the calendar for October alone. However, there are some who worry the pipeline might be drying up, along with the hefty subscriber growth NFLX enjoyed earlier this year as the pandemic took hold.

Those are among the questions analysts said they’ll have when NFLX co-CEOs Reed Hastings and Ted Sarandos discuss Q3 results in a videotaped interview Tuesday after the close. That’s their preferred method of sharing earnings news rather than the typical conference call with analysts.

Can Entertainment Keep Flowing Fast Enough?

NFLX has said the long lead time it has on content planning has paid off, but some analysts worry that’s about to end. They cite disruptions the entertainment industry overall has suffered at the hands of the coronavirus pandemic. 

In their July video banter, NFLX executives said they were itching to get back in production but would do it slowly and safely in parts of the world that were more open than the U.S. Analysts said they want to know how that’s working out.

Probably the most pressing issue, however, is membership growth. NFLX delivered jaw-dropping new subscriber numbers in the first half of the year, but warned investors those rates are unsustainable and to expect a significant slowdown in the second half. As of the end of the Q2, NFLX’s total global subscriber base sat north of 192 million, some 73 million of which were from the U.S.

For Q3, NFLX previously issued new subscriber guidance of 2.5 million. So that’s the number to beat.

Hastings has said in both quarterly reports he believes consumers who might have signed on in the second half already have by now and he sees a more measured membership growth into the rest of this year and 2021.

There’s also concern about churn, which might have been noisy for NFLX in Q2 amid the controversy over the “Cuties” film and the #CancelNetflix hashtag that began trending on Twitter in September.

Consumer Choice Could Mean Dials Turning

On top of that, the industry churn rate—a metric used to reflect cancelled subscriptions to streaming services overall—shot up 41% in Q1, the most recent statistic available, as consumers experimented with streaming during COVID-19 quarantines, according to research firm Parks Associates.

Some of that, of course, was likely tied to new competition that came online, including Disney+ DIS and Apple TV+ AAPL, Parks said. Disney+ alone roped in 49% of new subscribers, Parks added. But some analysts worry that may spell bad news for NFLX in Q3.

Wells Fargo & Co WFC analyst Steven Cahall expects “meaningful” and “short-lived but potentially stark” subscriber cancellations tied to “Cuties.” In a note to clients, he said Q3 net subscriber adds “could weigh more heavily … than investors realize.” He sees NFLX losing two million subscribers in the quarter compared with his earlier projection of a net gain of 500,000.

Still, he added: “We think the current controversy and elevated churn is essentially a flash in the pan for Netflix.”

Lightshed Partners analyst Rich Greenfield doesn’t appear too worried about the leap in churn or how long it might have lasted. In a recent note, he reiterated the “unprecedented industry scale” NFLX has over competitors that include Disney+, AppleTV+, AT&T Inc.’s T HBO Max , and Comcast Corporation’s CMCSA Peacock.”

“Netflix not only shrugged off competition, the COVID-19 pandemic has pulled forward industry change, breaking the theatrical business just as Netflix’s theatrical investments are starting to bear fruit,” he wrote. He upped his price target to $630 a share.

Goldman Sachs Group Inc GS analyst Heath Terry is in that camp too, boosting his target to $670 from $600, the highest listed on FactSet.

In his note to clients last week, Terry said he thinks NFLX results will be “well above guidance.” He’s forecasting “roughly 6 million net subscriber additions, driven by growth in content on the platform, a lack of competition for entertainment hours and spend, and more time being spent at home, potentially offset by churn levels modestly higher than we’ve seen in the past two quarters.”

NFLX shares lost as much as 15% in September but have since recovered and are now up 83% since bottoming in mid-March.

Popping Your Own Corn Free, But Chance Seen For Ticket Hike

Another point of interest for analysts and consumers alike could be the possibility of a price hike. NFLX unceremoniously ended its free trial for streaming services and upped subscription costs by $1 to $15 in Canada this month.

That immediately got tails wagging about raising prices in the U.S., which NFLX hasn’t done since January 2019.

“The Canadian price increase supports our view that broader price hikes are probable in the near-term,” Jefferies analyst Alex Giaimo wrote in a recent report to clients. NFLX, he added, “typically adjusts pricing every two to three years.”

We might get more word on that Tuesday. Analysts mostly believe NFLX will continue to offer cautious guidance of what’s ahead.

Goldman’s Terry, for one, expects a conservative forecast “given outperformance earlier in the year and the massive uncertainty of the current environment.”

But he’s still upbeat about the company’s future, believing NFLX should benefit from a “dramatically changing world” as the crisis continues to shift consumer behavior, Terry said.

NFLX Earnings And Options Activity

Netflix is expected to report adjusted earnings of $2.13 per share, according to third-party analyst consensus, on revenue of $6.38 billion, up 21.6% versus a year ago.

The options market has priced in an expected share price move of 8.5% in either direction around the earnings release, according to the Market Maker Move indicator on the thinkorswim platform.

Looking at the October 23 options expiration, put volume has been light, but concentrated at the 500 strike. Call activity has been higher, particularly at the 550, 560, and 600 strikes. The implied volatility sits at the 43rd percentile as of Monday morning.

Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation, to sell the underlying security at a predetermined price over a set period of time.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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