Netflix – This 13% Dip Doesn’t Make it a Buy.
Still the Streaming King, With or Without Warner Bros (A Q1 Review)
Last week, Netflix released its Q1 results and delivered strong numbers.
Revenue came in ahead of guidance and consensus, operating income grew 18% year-over-year, and the company demonstrated once again that its content flywheel, pricing power, and advertising ramp are all firing in the right direction. On top of that, Netflix walked away from the Warner Bros. saga with $2.8 billion in its pocket and a balance sheet in better shape than before the whole saga began. By most measures, this was a solid quarter from the undisputed king of streaming.
Nonetheless, investors stumbled over the fact that 1) the results didn’t blow expectations out of the water and 2) Netflix issued cautious Q2 guidance falling short of expectations. As a result, Netflix shares sold off by nearly 10% in the following trading session on Friday.
Nonetheless, shares have rebounded strongly from their 12-month low (even after the 10% post-earnings correction), gaining 28% from the early February low, but also remaining 30% below the 12-month high of $134. This puts shares in an interesting range.
Today, I want to take a close look at Netflix’s Q1 results, breaking down the numbers and assessing developments in order to update my view of the company, thesis, and financial forecast.
Does my long-term thesis hold up, and should we buy the dip? Let’s find out!
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Q1 Financial & Performance Review
Let’s delve straight into the numbers!
Netflix reported a Q1 revenue of $12.25 billion, beating the consensus by $80 million and coming in ahead of guidance. Furthermore, this reflects YoY growth of 16% (14% FX neutral). Growth was driven by membership growth, higher pricing, and increased ad revenue, similar to recent quarters.
Notably, management indicated that higher-than-planned subscription revenue drove the outperformance, helped by the return of big hits like Bridgerton and One Piece during the quarter, but mostly by the launch of the World Baseball Classic exclusively for Japan members. This event delivered 31.4M viewers, becoming the most-watched program ever on Netflix in Japan, and sparking the largest day of sign-ups in the country, also making it the largest contributor of member growth in Q1.
This is exactly why I am very bullish on Netflix and believe it can maintain double-digit growth for another decade. Apart from the fact that its TV viewership penetration remains very low, the company has plenty of room to enter new categories and expand beyond its traditional films, series, and documentaries.
Just like the World Baseball Classic or the NFL Christmas games, Netflix has a huge opportunity to expand into (recurring) live formats, particularly sports, with which it can address an entirely new audience. The results speak for themselves: these kinds of events draw in loads of subscribers, and Netflix is only just getting started. If it can consistently offer live content, that should also favor retention.
Most importantly, I see this as one of its key growth levers for driving subscriber growth. I expect Netflix to ramp up its efforts in this department in the coming years. It is reportedly already eyeing more NFL games per season.
The second driver of growth remains pricing, with Netflix hiking prices significantly in recent years. For reference, including the hike just last month, the price for a Netflix standard subscription in the U.S. is up 54% since 2020, with the Premium tier up 69%.
That is huge. Yet, the most important thing here is that Netflix has been able to do so without excessive churn. In fact, Netflix’s churn remains one of the lowest in the industry. The most recent data available points to churn below 2% for Netflix, which is sublime and actually hit its lowest level ever over the last 6 months. For perspective, Prime’s churn is around 4%, Paramount+ closer to 5%, Peacock at 7%, and Disney reportedly sits in the 3-4% range.
The reason is that Netflix is simply increasingly a necessity or must-have in every household, much more than any other streaming service. I see this in my own streaming activity as well. Netflix consistently has the most compelling content library and continues to deliver hit after hit, keeping me entertained.
Its content library and constant feed of top content are simply unmatched. While other streaming services see a good inflow with hit releases, but also a quick outflow once the hype is over, Netflix is performing much better in retention due to its must-have status.
This is what gives it massive pricing power and helps keep churn remarkably low, even amid significant price hikes. This is all the proof you need to conclude that Netflix is winning the streaming war. Most importantly, I think Netflix can continue to use pricing to fuel growth.
Additionally, this same must-have status and near-necessariness of the position make Netflix a reliable pick in uncertain times. This is why, while (U.S.) consumers are under increasing pressure, I am not too worried about Netflix.
Anyway, the 16% growth Netflix delivered in Q1 was healthy, even as it marked a slight slowdown from recent quarters. Nonetheless, growth remains in the low-teens range, where it has been for about 2.5 years, with no signs of a material slowdown.
Apart from growth in subscriptions and pricing, Netflix’s third monetization engine – advertising – is also performing strongly. The advertising subscription tier continues to see very strong adoption, now accounting for 60% of new sign-ups in Q1. Additionally, improved advertising capabilities have led to a strong influx of advertisers, with the total growing to over 4,000 by the end of Q1, up 70% YoY.
Fueled by this momentum, Netflix still expects over $3 billion in advertising revenue in 2025, up 100% YoY and poised to become a more meaningful contributor.
Finally, let me highlight the geographical performance. Growth in UCAN remained healthy, up 14% YoY and now accounting for 43% of revenue. This is a bit of a slowdown in growth compared to recent quarters, but I am not surprised considering the pressure the U.S. consumer is experiencing. Considering the operating environment, I find this a solid performance. Furthermore, FX-neutral, EMEA grew 12% YoY, LATAM 18%, and APAC 19%. EMEA also slowed a bit, but the other regions were mostly stable.
Let’s then move on to the P&L.
Netflix reported a Q1 gross margin of 51.9%, up 180 bps YoY, which is excellent. The gross margin has been trending up nicely in recent years. In 2023, Netflix reported a 41.5% gross margin, while the TTM gross margin is 49%, reflecting a 750 bps improvement in just over 2 years.
This gross margin expansion is driven by excellent pricing power, content cost leverage, and other factors. Driven by the business model and Netflix’s pricing power, the cost of revenue simply doesn’t keep pace with revenue growth.
You see, Netflix’s cost base is increasingly fixed while its revenue levers are multiplying. More subscribers paying more per head, monetized twice (subscription + ads), watching a catalog whose production cost was already sunk. That’s the textbook definition of operating leverage, translating into gross margin expansion, and there’s still runway left, particularly on the advertising side.
Therefore, I expect Netflix to keep delivering excellent gross margin leverage.
Further down the line, Netflix reported total Q1 operating expense growth of 24% YoY, outpacing revenue growth. This was driven by sales and marketing cost growth of 22% YoY, technology and development costs up 17%, and G&A up 43%.
As a result, Netflix’s operating margin didn’t keep pace with its gross margin expansion, but growth remained firmly positive, with the operating margin up 60 bps YoY to 32.3%, primarily driven by a better gross margin. This led to 18% growth in operating income to $4 billion, still slightly ahead of guidance, thanks to higher-than-expected subscription revenue.
Ultimately, this translated into a net income of $5.28 billion or an EPS of $1.23, but this includes the $2.8 billion paid by Warner Bros for the breakup of the deal.
Finally, Q1 FCF was $5.1 billion, also including the $2.8 billion paid by Warner Bros. Excluding this, FCF was $2.3 billion, bringing the TTM total to $9.09 billion at a 19.4% FCF margin.
As shown above, Netflix has rapidly become an FCF machine. The company now delivers nearly $10 billion in FCF annually, which is very impressive against a production budget of over $20 billion. No peers can match this level of cash flow.
And this is also what allows Netflix to maintain a healthy balance sheet. The company ended the quarter with $12.3 billion in cash and $14.4 billion in gross debt, leaving it in a net debt position of just over $2 billion, which is more than fine against an annual FCF of $9-10 billion.
As shown below, Netflix has consistently brought down debt and improved its financial health in recent years, going from $12.1 billion at the end of 2021 to just $2 billion as of Q1.
While the company temporarily halted buybacks during the Warner Bros. acquisition process, Netflix quickly resumed them once the deal fell through, still managing to buy back $1.3 billion in shares in Q1. And just an hour ago, the company announced an additional $25 billion buyback program, bringing the total remaining authorization to $31.8 billion.
This move is not surprising at all, with the improved balance sheet allowing Netflix to buy back shares aggressively, especially given that shares are well below all-time highs. For reference, buybacks have allowed Netflix to retire 2.3% of its shares in 2024 and 1.1% in 2025.
To round up this financial and performance section, it is absolutely worth highlighting Netflix’s sublime reinvestment metrics and its direction of travel. Netflix’s LTM ROE now is 49%, and its LTM ROIC is 31%. And as shown below, both have been trending up consistently and strongly in recent years, which is exactly what investors want to see – Netflix isn’t just generating strong returns; it is getting more efficient at doing so with every dollar it retains and reinvests.
For a long-term buy-and-hold investor, consistently rising ROIC is one of the clearest hallmarks of a compounding machine.
The Warner Bros Deal
Of course, one of the most important developments during Q1 was the Warner Bros deal falling through for Netflix, so there is no way around addressing it briefly before getting to the outlook.
