Netflix: Rental Dominance on Display

Netflix (NFLX) stock has surged 22% thus far in Thursday trading, as the last quarter demonstrated just how strong their growth was in the past year. Net subscriber gains were up 31% from a year ago to a total of 12.26 million, and the video rental site added more than a million in just the last quarter. In addition to this growth, they also lowered their churn rate to 3.9% from 4.2%, which suggests people are generally pleased to continue paying for their service and was a nice change from previous quarters. Netflix was able to expand its gross margin nicely as well as it came in at 38% compared to just 35.2% a year ago. Part of this margin expansion is due to the ability for customers to stream content online versus actually needing a physical disk mailed to their home. This growth translated into an easy earnings beat: analysts were expecting $.45 per share but reported EPS was much stronger results of $.56.

Many investors have doubted Netflix’s ability to maintain such impressive growth and validate its lofty multiple, as you can tell from the high percentage of floated shares sold short coming into the day. So, today’s explosive share price appreciation probably owes a little bit of the momentum to a short squeeze. The company’s strong quarter combined with their glowing outlook surely scared off many of the shorts. The company expects to end fiscal 2010 between 15.5-16.3 million subscribers. The low end of that range would imply a subscriber growth rate of 26%. Netflix expects first quarter EPS to be in the range of 47 to 58 cents per share, which is well above the consensus view of $.44 coming into the day.

Thanks to savvy partnerships and a relentless effort to improve their product offering through streaming capabilities, Netflix has found a sweet spot in this industry. Their business model is putting a strain on the competition as just today bricks-and-mortar video rental chain Movie Gallery Inc announced today that they will restructure through bankruptcy, possibly filing as soon as next week. Movie Gallery will likely need to close up to two-thirds of its 1800 locations and make significant layoffs in order to rein in costs. Blockbuster (BBI), the former industry giant, just reported a wider than expected loss last week caused by poor holiday sales. The company reported a 60 cent loss on the quarter versus analysts’ calls for just 11 cents lost per share. Coinstar’s (CSTR) Redbox is one of Netflix’s only competitors to actually show positive earnings and sales trends, but we think there is clearly enough room in the industry for these two movie rental options.

After today’s incredible advance, we are reaffirming our Fairly Valued stance on NFLX. A number of analysts have raised targets and ratings on the company as the results have been digested. Why wouldn’t they? This company continues to surpass most expectations, and it is crushing many of its competitors who just cannot compete with the simplicity and cost structure of their model. One thing is for sure, we would not be among those willing to bet against this company anytime soon, and we imagine more than a few who shorted this stock are realizing the same feeling today.

Netflix: Rental Dominance on Display

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