Time to Forget Netflix & Press Play on Streaming Giant

Netflix (NASDAQ:NFLX) really bucked the trend after its most recent quarterly earnings report, which can justifiably be described as out of this world.

Rising 12.5% in just a 5-day period, Netflix left the performance of the S&P 500 far behind in its rearview mirror, posting a 3.04% loss over the same time period.

But if you’re looking for an undervalued streaming giant to ride the wave of cord-cutting, perhaps it’s best to look where most investors aren’t, at rival Warner Bros Discover (NASDAQ:WBD).

Amid Netflix Fanfare, Warner Bros Is Missed

A lot of investors have got caught up in the Netflix move recently, but Warner Bros Discovery has been impressing too. 

Take the company’s 12-month revenues, for a start, which are up from $10.7 billion in the first quarter of 2021 to $41.8 billion in the most recent quarter. The spike is not organic but rather stems from the closing of the Discovery & AT&T WarnerMedia transaction.  Nonetheless, the top line is nothing to sneeze at now, posting revenues of $10.3 billion last quarter.

But the financials are not all rosy at the media giant with a string of operating income losses over the past 5 quarters, bucking the prior trend which had seen a steady and predictable flow of operating profits hitherto.

With operating income in the red to the tune of $789 million last quarter there is some serious risk on the horizon, which we’ll explain below.

The Elephant In the Room

Peter Lynch famously said that a poor company can be spotted by examining its balance sheet. Specifically, when a business is laden with debt, the effect is to essentially anchor it, acting as a drag against forward progress.

Warner Bros Discovery currently has debt of $44.3 billion, which is deeply concerning to investors because cash sits at just $3.0 billion.

When you factor in the $789 million in operating losses quarterly, you can quickly see that the runway is fast nearing an end for Warner Bros Discovery before a liquidity event materializes.

The company is at serious risk of running out of cash within the next 4 quarters, absent asset sales or cost cutting. The assets on the books are listed at $13.7 billion and provide optionality for management to raise cash to pay off some of the debt burden.

Alternatively, management can look to the income statement to cut expenses that would free up more cash flow. 

In spite of those concerns, there is room for optimism on a closer look at the valuation.

Is Warner Bros Discovery Stock Undervalued?

Warner Bros Discovery stock is undervalued by 74.2% based on the view of 25 analysts who have a consensus price target of $18.75 per share on it.

A discounted cash flow forecast analysis would suggest less optimism with a price target of $13.78 share, representing upside potential of 33.4%.

Another metric that favors the bulls is the price-to-sales ratio over the past twelve months, which sits at 0.6x, well below the sector average of 1.4x.

With all that said, bears have some tangible reasons to cling on to pessimistic forecasts because earnings per share have been in the red, so a price-to-earnings ratio comparable with peers does not apply.

Indeed when you compare Warner Bros Discovery with Netflix, a few key metrics favor the latter.

Netflix Leaves Warner Bros In the Dust

One key metric investors can look to when comparing the two firms is return on invested capital.

Netflix has a ROIC of 14.2, suggesting that it enjoys a wide economic moat. That’s not entirely a surprise given that it has established a presence in the minds of consumers as a trusted brand. Warner Bros Discovery enjoys some level of brand loyalty via HBO and CNN but not to the same extent.

Similarly, where Warner Bros Discovery posted an operating loss of almost $800 million last quarter, Netflix posted a gain just shy of $2 billion. That kind of $3 billion differential is what makes investors rush to Netflix, as they have in droves.

Even though Netflix has been on a good run, rising 12.5% in the past week alone, a discounted cash flow forecast still suggests it has as much as 26.7% upside to fair value at $508 per share.

And in contrast to the analysts downgrades that WBD has been receiving recently, Netflix has been on the opposite end of the spectrum, earning 13 upgrades from analysts revising guidance higher near term.

Final Thoughts

While Warner Bros Discover has upside of between 33.4% and 74.2%, depending on whether a DCF or analysts ratings are used, investors’ concerns over debt levels need to be respected.

It would appear now that WBD has about 4 quarters only to get its proverbial ducks in a row, meaning to shore up the balance sheet, which is rapidly running out of cash, it must dispose of key assets or it must severely cut costs.

It’s very possible that the announcement of such news events would spark a rally in WBD share price but it would be a brave investor who bet on a positive outcome at this stage.

By contrast, Netflix with its rising subscriber numbers versus peers such as Disney+ who are sliding backwards, in addition to its close to $2 billion in operating profits quarterly and upside potential based on a DCF and analysts price targets is likely the better investment option at this time, for all but the most risk-seeking of investors.

If you had to pick between Netflix stock that has already popped higher or Warner Bros Discovery that has remained muted, the former remains more attractive on most of the key financial metrics.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.