Will Netflix’s Year Take a Wrong Turn?

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

Netflix (NASDAQ:NFLX) will report Q1:13 results after market close on Monday, April 22, and host a call at 3:00pm PT (Dial-in: 760-666-3613, webcast: http://ir.netflix.com).

We expect Q1:13 results at or above the high end of guidance. We expect revenue of $1,031 million and EPS of $0.22 vs. guidance for $1,004-1,031 million and $0.00-0.23, and consensus for $1,017 million and $0.18. We expect 29.2 million domestic streaming subs, compared to guidance of 28.5-29.2 million. The February debut of House of Cards and mid-March Facebook (NASDAQ:FB) integration in the U.S. likely drove Netflix to the high end of domestic subs guidance.

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Cost control should allow it to meet or exceed the high-end of EPS guidance as well. On April 11, CEO Reed Hastings disclosed that members had watched over 4 billion hours in the previous three months, compared to over 3 billion in Q3:12. In our view, increased viewing likely reflects high end subscriber numbers (enhanced by House of Cards),with approximately 5 percent higher average viewing per subscriber.

Our Q2:13 subs estimate may be too conservative. In the Q4:12 Investor Letter, management disclosed that it expected fewer net adds in Q2:13 than in Q2:12 (when it added 0.53 million domestic streaming subs) due to seasonality. As a result, we modeled 0.50 million net adds. However, the launch date for Arrested Development (May 26) is close to quarter-end, so fewer subs are likely to churn in and churn out in Q2, potentially an issue for House of Cards

We believe Netflix will face a number of challenges in 2H:13. In our view, the company’s two most high-profile 2013 exclusives were released in the first half of the year. In addition, management could face a difficult decision about whether to resume international expansion, potentially improving long-term subs growth while forgoing near-term profitability. Also, competition will undoubtedly continue to intensify.

We do not expect Netflix to provide fiscal year 2013 guidance. The management appears content keeping investors focused on near-term results due to many long-term variables (unclear impact of originals, increasing content costs, and competition).

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Initiating our fiscal year 2014 estimates: Although we expect top-line growth from modest subs growth, we believe rising content costs will limit EPS growth.

Maintaining our UNDERPERFORM rating and 12-month price target of $55, which reflects a sum-of-the-parts that values domestic streaming ($28/share), domestic DVD ($20/share), and international streaming ($7/share).

Michael Pachter is an analyst at Wedbush Securities.

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