Netflix Stock Falls After Solid Earnings. What’s Behind the Drop.

Ginny & Georgia is one of Netflix’s biggest hits. Here’s a scene from Season 3. (Courtesy Netflix)

Netflix beat expectations for its second-quarter earnings results Thursday afternoon, but much of the strength came from a weakened U.S. dollar. However, the stock pointed 4% lower in Friday trading.

The company reported $7.19 a share in earnings, ahead of Wall Street’s consensus estimate of $7.08, according to Factset, and up from $4.88 last year. Revenue for the quarter reached $11.08 billion, just above expectations of $11.06 billion, and up 16% on the year. Operating profit margin also exceeded expectations.

The company’s outlook for the third quarter was solid. The company’s projection of $6.87 a share in earnings is better than analyst estimates of $6.69. Netflix guided to revenue of $11.56 billion versus the expectation of $11.28 billion.

But the company explained in its shareholder letter that all of these beats came from a weaker U.S. dollar in the second quarter than Netflix anticipated three months ago when it gave guidance.

Created with Highcharts 9.0.1Netflix shares have nearly doubled in the​past year.Source: FactSetAs of July 17

Created with Highcharts 9.0.1Aug. 2024'254006008001,0001,200$1,400

Netflix got 59% of its sales from abroad in 2024, which are subject to the whims of exchange rates. In the second quarter, 56% of revenue came from outside North America. When the dollar weakened, Netflix earned foreign revenue in strengthening currencies like the euro, but booked it in the weakening dollar.

Netflix also raised its annual guidance, though “it primarily reflects the foreign exchange impact from the weakening dollar relative to most other currencies,” said Chief Financial Officer Spencer Neumann on the earnings call. “But the good news is we’re also seeing strength in our underlying business. We’ve got healthy member growth… and we’re also seeing nice momentum in ad sales.”

“This is arguably the core theme of this report—given the highly favorable FX backdrop for a company with such a globally diversified revenue base, the market was expecting a much stronger upward revision to full-year guidance,” said Thomas Monteiro, analyst at Investing.com. “That didn’t quite materialize, despite another standout quarter for the streaming giant.”

Shares of the Ginny & Georgia streamer were down 4.2% to $1,221.

After its sales growth slowed in 2022, Netflix pulled two levers to turn things around. It cracked down on password-sharing and began offering a less expensive ad-supported tier.

The initiatives were successful, and now Netflix has notched seven quarters in a row with double-digit revenue growth. The stock price has reflected that, up 134% since Netflix reported the first of those quarters in January 2024. The S&P 500 index was up 29% in the same period.

This run has stretched the stock’s valuation, trading at 44 times expected earnings for the next 12 months, close to its three-year high. Other valuation metrics are similarly inflated. Netflix needed a perfectly clean sheet, with no offsetting exchange rate effects

For Netflix to keep up, the ad tier will have to continue its rapid growth. According to Melissa Otto, the head of Visible Alpha Research at S&P Global, it saw $1.9 billion in 2024 sales and is expected to get $3.9 billion this year, making it an important driver for the whole company.

Ads may also be more profitable than subscriptions. The company’s operating profit margin has been growing, at 34% in the second quarter, a new record and up from 32% sequentially.

“Netflix has built a formidable entertainment platform and is in the early stages of developing a promising digital advertising franchise,” said analyst Brian White of Monness, Crespi, Hardt in a note to clients. “We expect Netflix to enjoy continued momentum on the digital advertising front, benefit from higher monthly subscription prices, and release a steady flow of new content.”

Netflix has survived an onslaught of new competition in the past few years from Disney, Amazon, Apple, and more. According to Nielsen’s June U.S. viewing data, Netflix easily tops all but Alphabet’s YouTube, whose viewing share has increased from 9.9% a year ago to 12.8% in June, with Netflix trailing with 8.3%. The next closest is the combination of Disney’s three streaming services at a 4.8% share.

Increasingly, Netflix squares off with YouTube while the rest compete with each other. The wild card is TikTok, which may become a larger part of the picture down the road.

Write to Adam Levine at adam.levine@barrons.com