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1 Green Flag For Netflix in 2022, and 1 Red Flag

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The market is focusing on the bad news with Netflix, but investors should not overlook a major silver lining.

Netflix (NFLX 1.15%) has experienced more than its fair share of ups and downs since the pandemic's onset. Initially, it thrived as billions of folks stuck at home had to entertain themselves. Netflix was an easy choice with its most expensive plan costing less than $20 per month.

But today, the stay-at-home trend has reversed, and people are spending more time out of the house. That's creating a headwind for Netflix and a significant red flag for the streaming business in 2022. The market has focused on this fact more than anything else, with the stock is down 37% year to date. Meanwhile, the company reached a large enough scale to sustain itself financially. Management said it would be free cash flow positive for 2022 and beyond -- a green flag, to be sure.

Image source: Getty Images.

Green flag: Netflix turns the corner on free cash flow 

Netflix has been net-negative on free cash flow (FCF) for several years. The company was investing aggressively in creating and buying content for its streaming platform. The hope was that eventually, it would reach a large enough scale and build a deep enough library where the cash coming in would surpass the money going out. It looks as though that time has come. In its fourth-quarter shareholder letter, the company stated it would be FCF-positive in 2022 and beyond.

The statement comes as Netflix eclipsed 222 million streaming subscribers as of Dec. 31. The mass of customers brought in overall revenue of $29.7 billion in 2021, and the company is on pace to bring in more for 2022. Even with the nearly $30 billion revenue, generating positive FCF was not a foregone conclusion. Netflix spent $17.7 billion in expanding its content library in 2021, and combined with other spending, the company was FCF-negative for the year completed on Dec. 31.

If Netflix can generate free cash flow from now on, it will lessen its reliance on financial markets to raise capital for operations, thereby lowering market risk. 

NFLX Free Cash Flow data by YCharts

Red flag: Slowing subscriber growth 

Subscriber growth surged for Netflix at the initial stages of the pandemic. Now that economies are reopening, more people have been vaccinated against COVID-19, and pent-up demand for social activities is being unleashed, it's not a surprise that subscriber growth is slowing for Netflix. 

2017 Q1 2018 Q1 2019 Q1 2020 Q1 2021 Q1 2022 Q1E
5.3m 8.3m 9.6m 15.8m 4.0m 2.5m

Source: Netflix Q1 subscriber growth in millions. Chart by author.

The chart above shows Netflix's subscriber growth in the first quarter for the previous five years and the forecast for Q1 in 2022. Note subscriber growth is the change in total subscribers and includes additions as well as cancellations. If Netflix delivers on the estimates, it would be the second year in a row of attracting below-average subscribers in Q1. 

One notable change has been weighing on its ability to attract and retain paying members: competition. Several major studios launched their own streaming services in the past few years and Netflix now faces stiff competition, whereas it faced little for nearly a decade. Some rivals offer their services at lower prices, including ad-supported versions that cost even less. Investors have good reason to think Netflix's subscriber growth is being impacted by the competition.

Netflix's red flag is taking center stage, and the stock is down 45% off its all-time-high. Of course, it does not help that Netflix's struggles arose when market volatility has pushed tech stocks lower. That said, the company's inflection point on free cash flow should not be underestimated. Even if you agree with the bears that subscriber growth will keep slowing due to market saturation, Netflix has reached a large enough scale to deliver excellent profits and retain a competitive moat with a massive content budget. All things considered, it's a good time for long-term investors to start accumulating shares of Netflix.

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