Stockwatch: Netflix might interest traders after this shocker

Our companies analyst gives a summary of US bank sector results and shares his take on Netflix results.

Chief upshots of the first week of US second-quarter reporting are the sharp contrast in performance of the banks, reflecting the tsunami of monetary stimulus, and Netflix (NASDAQ:NFLX) priced around 10% lower before the market opens today, after last night’s results failed to meet high expectations.

Otherwise, US stocks have generally seesawed amid fresh concerns about Covid-19 infections and its impact on economic recovery. 

Commercial banks shiver, investment banks shine

Banks have proved the mixed bag I suggested they would be in my article on Tuesday. Those oriented to commercial and personal loans having profits hit by provisions for bad debts, while leading investment banks basked from Federal Reserve stimulus boosting securities trading. Capital-raising and advice also helped as firms shored up balance sheets, lest tough times persist.

JPMorgan Chase (NYSE:JPM) kicked off with numbers ahead of expectations, albeit setting a theme of billions of dollars worth of loan provisions ahead. Citigroup (NYSE:C) was mixed - revenue up, profit down - while Wells Wells Fargo (NYSE:WFC) fell 7% after profits came in 20% below expectations and management guided for a 27% decline in underlying earnings over the next two years. Often, when I look at US banks, Wells Fargo seems to be under-performing, although it’s still a wary portent for the US economy. 

Bank of America (NYSE:BAC) is more a universal bank (blending commercial and investment activities) having swallowed the remnants of Merrill Lynch, now its wealth management side. Profits halved to $3.5 billion on revenue 3% easier at $22.3 billion, still substantive. Fixed-income trading revenue leapt 50% and by 7% for equities, while advisory fees soared 57% to a record $2.2 billion including an 87% advance in equity issuance. Debt advisory also did well as companies took advantage of interest rate cuts.

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Showing how tricky US bank shares are to decipher and trade currently: BofA’s earnings per share (EPS) came in 32% ahead of cautious expectations, yet the shares still eased over 2% as the market justifiably sees this as an extra-special quarter. The worry about those driven by commercial loans is Federal Reserve stimulus delaying worse pain ahead, with a bulk of losses maybe from the fourth quarter, peaking maybe mid-2021.

Leading investment banks have smashed expectations. Morgan Stanley (NYSE:MS) has delivered earnings up 45% with EPS of $1.96, way ahead of consensus for $1.12. Both revenue and profit were quarterly records for the bank. Its wealth management side contributed $4.7 billion of $13.4 billion revenue; these being relatively stable fees based chiefly on assets under management, which rose in value. Trading and advisory income also rose by about two-thirds, hence the bumper overall outcome.

Goldman Sachs (NYSE:GS) rose nearly 4% in response to EPS of $6.26 way ahead of $3.78 consensus, on $13.3 billion revenue versus $9.75 consensus. This was Goldman’s biggest out-performance in nearly a decade, with securities trading revenue $2.5 billion ahead of expectations. Is the Fed justified in helping out Wall Street titans to this extent?

Netflix shares plunge after bulls are humiliated

If you are close to succumbing to the mantra from equity bulls that there is nowhere else for money to go other than stocks, see how they are now spectacularly wrong on Netflix; how a bit of common sense about “mean reversion” is wise.

Ahead of second-quarter results for this producer and streamer of global TV/film content, sentiment had been bullish with brokers upgrading. Morgan Stanley argued for Netflix as a core holding because it enjoys benefits of greater scale and audience time, pressuring its competition especially TV broadcasters. Its analysts expect Netflix to pass 200 million members this year, just three years after achieving 100 million, and had raised their target from $485 to $575 with an ‘overweight’ stance ahead of the results. 

Also, BMO Capital raised its target from $500 to $625 on the basis perception of Netflix will move on from the “stay-at-home” theme that benefited it – and also Amazon (NASDAQ:AMZN) – from mid-March, to booming cash flow in due course. And Barclays hiked its target from $420 to $550, an ‘overweight’ stance on the basis market expectations for third quarter 2020 guidance were relatively subdued. Netflix’s rich content makes for a tailwind at a time when much revival of sports viewing remains uncertain. 

Yet on an essential reading of valuation and crowd psychology, the stock had already reached a price/earnings (PE) multiple over 100x – “well up with events” arithmetically, even if expecting this to come down with strong growth going forward. There is no dividend, and asset-backing can be fleeting as media content constantly evolves. Newer rivals such as Apple TV mean competition.

(Yes, Amazon enjoyed PE multiples over 100x in its earlier years, but had quite a monopolistic grip on e-commerce until manufacturers/retailers got their act together – and they still defer to Amazon, pushing product through its channels, often at discount prices because Amazon has muscle.)

You could see how Netflix shares were teetering yesterday, off 2% mid-afternoon versus this bullish consensus being flagged in media, and down around 7% on a $550 high only a week or so ago. Price action flagged tiring sentiment, and numbers really had to surprise on the upside again.

Source: historic Company REFS

Subscribers up, but third-quarter guidance down

Yes, Netflix was able to gain 10.09 million more subscribers than expected, albeit in a quite exceptional quarter with people unable to watch live events or frequent movie theatres. This also translated into revenue up 24% to $6.15 billion versus expectations for $6.08 billion.

Yet management has adjusted down its guidance for subscribers in the third quarter: admittedly only to $6.33 billion versus analyst expectations of $6.40 billion, though any sense of “slowdown” is a dilemma when a stock is priced for perfection. 

Otherwise, key numbers were mixed: latest revenue slightly ahead of expectations, but EPS 9% lower than hoped. Global paid net subscriber additions were 22% better than expectations although lockdowns have made for an exceptional quarter.   

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Not surprisingly, bulls insist on keeping the wider context in focus; how the pandemic is not going away soon and is accelerating a shift from linear TV to streaming video. Netflix to extend its lead in global entertainment services overall: this year expected to reach 72% of viewers, versus 60% for Amazon Prime and 39% for Hulu.
Yet, moderating third-quarter guidance is still quite some twist in the story, versus a massive beat in the first quarter of 2020 when Netflix achieved 15.8 million versus 7 million anticipated. 

A fundamentally stretched valuation

At yesterday’s closing price of $527, Netflix was capitalised at $232 billion, possibly 8x to 9x sales for this year. Such a market value leaves no room for any deterioration in the story, while the chart implies scope for pull-back to $460 assuming the recent trend-line.

Yet it may make no sense to rely on chart patterns recently distorted by the gross effect of monetary stimulus, also the exceptional underlying factor of so many people having been in lockdowns, globally.

On a five-year projected basis, Netflix’s price/earnings-to-growth ratio (PE divided by projected earnings per share) is 2.4x versus the normal sense with growth shares, of value existing below 1.0 and to pay up to 1.5x only in exceptional cases. Again, such assumptions were pre the colossal monetary stimulus helped distort US equity values. 

Before these results about 2.5% of Netflix equity had been sold short, as if in some acknowledgement of this. Obviously, such traders have targeted Tesla (NASDAQ:TSLA) for years, only to lose their shirts.

Can Netflix grow into this valuation?

It would appear the crux issue for longer-term investors, aside from near-term issues in the US culture of quarterly reporting, liable to be a distraction. My view is of Netflix remaining exposed to mean reversion in the short to medium term, which also means it can overshoot on the downside technically, before the stock’s fan club attempts to rescue it.

So, if you are up for brave trading this afternoon and evening, tune into Netflix dynamics and look for an intra-day low. I can’t say how durable any bounce will prove, however; this stock is now wholly a function of sentiment. Until recent high hopes have abated, and genuine prospects are better reflected in price, investors should avoid.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.