A surprising step back

Connecting the dots

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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Telstra Corporation Ltd (ASX: TLS) shareholders might be forgiven for being a little nervous about their dividends. After all, Telstra used to be regarded as one of, if not the best, ASX dividend shares on the market. That's the reputation a couple of decades offering a fully franked, ~7% dividend yield can build.

However, that all came crashing down in 2017. That's when the ASX telco slashed its annual dividend from 31 cents per share to 22 cents per share. It hit investors again in 2019, reducing the 22 cents per year to 16 cents. That remains the annual payout Telstra shareholders have been receiving to date.

Last October, Telstra promised to keep this dividend steady at 16 cents in 2021 and perhaps beyond. Here's some of what Telstra CEO John Mullen said at the time:

The board is acutely aware of the importance of the dividend to shareholders, and we understand the nervousness from some that COVID and other pressures may force Telstra to again cut its dividend… The board clearly understands the importance of the dividend and if necessary is prepared to temporarily exceed our capital management framework principle of paying an ordinary dividend of 70-90% of underlying earnings to maintain a 16c dividend.

Well, so far so good. In March, Telstra paid out another dividend of 8 cents per share, keeping to this commitment.

Does AT&T spell trouble for Telstra shares?

But a piece of news out of the United States might be getting investors worried about Telstra's dividend of late. AT&T Inc (NYSE: T) is one of the largest telcos in the US. It bears many semblances to Telstra, given its old role as a monopolistic telephony service provider.

Recently, AT&T announced a big restructuring, which will include a large dividend cut. It will end AT&T's dividend aristocrat status on US markets. Until now, the company had raised its dividend every single year for 36 years.

Could this be a canary in the coalmine for Telstra?

Well, the company doesn't think so. In February, Telstra delivered its results for the first half of FY2021. It discussed its dividend further at that time. Here's some of what the company said:

Our aspiration [is] for mid to high single digit growth in Underlying EBITDA for FY22 and for Underlying EBITDA to be in the range of $7.5–8.5b in FY23. This range is important to support a 16c dividend inside our dividend payout ratio and to deliver a ROIC of around 8%. We know how important this dividend is to our shareholders and that is why and the board expects to pay a total dividend for FY21 of 16c per share including an interim dividend of 8c per share. 

So, in other words, Telstra remains committed to its current dividend, which it thinks it can afford if sufficient earnings growth is achieved (which the company evidently thinks it can hit). If this proves to be the case, it's good news for Telstra's dividend-conscious investors.

On the current share price of $3.45, Telstra's dividend is worth a yield of 4.64%. Or 6.63% grossed-up with Telstra's full franking.

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Netflix (NASDAQ: NFLX) is losing market share to be sure -- but consider the circumstances. It was the first company to make streaming video a mainstream phenomenon, and for years, it was the only serious name in the business. It's only natural that the recent launches of big rival services such as Disney's (NYSE: DIS) Disney+ and AT&T's (NYSE: T) HBO Max would chip away at Netflix's share of the on-demand video space.

But there's room for more than one winner in this business, and Netflix's market-leading 204 million paid worldwide subscribers is still only a fraction of its total addressable market. Shareholders need not ramp up the anxiety levels just yet.

Stock-picking can be a funny business. Sometimes investors may use all the wrong reasons to mentally justify why a company deserves to be priced at a steep premium, but then quickly change their minds with little to no warning when circumstances shift.

It's this phenomenon that should make the streaming market's new entrants so concerning to Netflix shareholders. We've never actually seen Netflix forced to compete seriously until now. To the extent that its commanding market share and impressive growth rates are the reasons the stock's price-to-earnings ratio has lingered above 60, current investors should at least be cautious.

Netflix is losing ground

Continued dominance of a market is never guaranteed. Just ask investors of Yahoo!, MySpace, or IBM. There was a time when shares of IBM and Yahoo! were priced as if those companies would never stop growing, while privately held MySpace fetched a price of $580 million when News Corp. acquired it back in 2005 -- and was in 2007 valued at around $12 billion. Six years after News Corp. bought it, MySpace was sold again -- for $35 million. Competitors stepped up to the plate, as they always do.

Netflix is no MySpace, to be clear, but it wouldn't be a stretch to suggest that its best days are behind it. As tough as things have been competitively speaking over the course of the past year, they're only going to get tougher as players like HBO Max, Disney+, and Hulu step up their streaming games.

Data from market intelligence outfit eMarketer lets us flesh out this trend with some numbers. It reports that Netflix secured 36.2% of the U.S. over-the-top television industry's revenue in 2020, down from 44.4% in 2019. By 2022, its share is expected to be down to 28.4%, and almost even with Disney's slice of the U.S. streaming market.

That math is roughly in line with similar research from Ampere Analysis suggesting Netflix lost 30% of its U.S. market share last year.

Its next customers won't come cheap

In its defense, Netflix is winning a relatively smaller piece of a rapidly growing pie. Last year's revenue of $25 billion was up 24% year over year, propelled by subscriber growth at a similar rate, and its profits grew at nearly twice that pace. While year-over-year revenue gains are projected to slow, earnings growth is forecast to remain robust through 2025. This may be why Netflix shares continue to trade at 91 times trailing earnings and 57 times forward earnings.

That's a profit outlook, however, seemingly based on the assumption that per-subscriber marketing costs will remain suppressed. They won't. They can't.

See, players like AT&T and Disney are increasingly supporting their fledgling streaming platforms and gaining traction with their efforts. Whereas eMarketer forecasts that Disney and Netflix will be equals within the U.S. by 2022, Digital TV Research's principal analyst Simon Murray predicts Disney+ will dethrone Netflix as the nation's streaming leader sometime between 2024 and 2026. Disney itself says it's expecting to have between 230 million and 260 million Disney+ subscribers by 2024, versus Netflix's current headcount of 204 million. Netflix will be forced to respond, likely starting with more -- not less -- spending on marketing, or content, or both.

Indeed, after reining in its marketing spending early in the pandemic, in the fourth quarter, the company ramped it back up. The result was that marketing spending ate into last year's surge in operating income ... almost dollar-for-dollar. Yet Netflix only picked up a relatively modest 8.5 million subscribers for the fourth quarter, despite the boost to its marketing outlays.

Data source: Netflix. All dollar figures are in thousands. Chart by author.

The message? The streaming market's cheap, the low-hanging fruit has been picked.

Bottom line

It's clear that Netflix's status as the bully on the block is in jeopardy. To what degree that matters remains to be seen. Just know that not much takes the wind out of a stock's sails like seeing the underlying company lapped by a newcomer, or seeing its market share chipped away by a flock of new competitors. Just ask IBM, which was once the dominant name of the business computing industry, but was ultimately upended by a combination of Intel, HP, and the army of motherboard manufacturers they led away from IBM's ecosystem.

NFLX data by YCharts.

Given all of this, it's curious that Netflix shares have considerably underperformed the broad market over the course of the past six months -- a period when the appeal of a host of new streaming competitors became clear. It may be a subtle, subconscious hint of the market's brewing doubts about Netflix stock's steep valuation. Perception isn't everything, but it's certainly a lot.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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AT&T (NYSE: T) took on Netflix (NASDAQ: NFLX) and other video streaming rivals with the launch of its HBO Max service last year. But any comparison between Netflix and AT&T requires a look into how AT&T's streaming service fits into its larger telecom business.

Through this lens, is AT&T a better stock buy than Netflix? Here's how the telecom titan stacks up against the streaming entertainment pioneer.

AT&T's strategy

Despite HBO Max, AT&T's key competitors aren't the likes of Netflix; they're telecom rivals like Verizon Communications.

With the U.S. telecommunications market at a saturation point, AT&T and its competitors are forced to snatch customers from one another to grow subscribers. Holding on to its customers is AT&T's top priority, and as CEO John Stankey said, "HBO Max is the key here."

By bundling telecom services with HBO Max, AT&T hopes to retain customers while enabling the company to capture a higher average subscription price. To this end, AT&T shook up the entertainment industry last December by announcing plans to release its WarnerMedia-produced theatrical film slate to HBO Max at the same time it releases them to theaters in 2021.

Its fourth-quarter results suggest the strategy is having an impact. AT&T experienced growth in postpaid subscribers, the telecom industry's most valued customers, for the second quarter in a row. AT&T added 1.2 million postpaid customers, the highest net adds in some time.

 

Data source: AT&T. 

It combined this growth with the second-lowest quarter of postpaid phone churn in the company's history. It also doubled the number of fourth-quarter HBO Max subscriptions over the previous quarter.

But despite these promising trends, AT&T has struggled since the pandemic struck. The company's 2020 full-year revenue dropped to $171.8 billion from 2019's $181.2 billion.

The diminished revenue hurt the company's efforts to pay down a massive debt load accumulated to acquire Time Warner (which included HBO) and DIRECTV. The latter is like an anchor dragging on AT&T's operations as the service bleeds subscribers.

The financial impact was perhaps most apparent when the company failed to raise its dividend in 2020 after 36 consecutive years of dividend increases. Its high-yield dividend is one of the key reasons investors are attracted to the stock.

Netflix's success

Netflix helped pioneer streaming video entertainment, allowing it to ride a rocket ship of revenue growth spanning years.

Data by YCharts.

The trend continued through the company's most recent quarter. Netflix enjoyed a strong fourth quarter, with paid subscription memberships rising 21.9% year over year.

The company anticipates continued membership growth in the first quarter, rising to 209.7 million subscribers from the previous quarter's 203.7 million. Netflix also expects first-quarter revenue to reach $7.1 billion, up 23.6% from last year.

Membership growth was helped by pandemic-induced stay-at-home restrictions, but when you dig into the numbers, it's also the result of a successful strategy. Netflix invested in content attractive to an international audience. The company developed original programming in German, Korean, Spanish, and other languages.

As a result, Netflix's member growth was powered by international adoption. Of its 2020 net additional memberships, 83% came from markets outside North America. Even better, these local titles also possess global appeal. Its French-language heist series Lupin was a hit around the world, ranking second in Netflix's top 10 in the U.S.

This strategy bodes well for its ability to continue capturing subscriber growth and revenue. Moreover, CFO Spencer Neumann indicated the company turned a corner and expects to break even on a cash flow basis this year and be cash flow positive from 2022 onward.

Despite the successful strategy, Netflix lost market share as more competitors entered the fray. As co-CEO and chief content officer Ted Sarandos says, people have tremendous appetites for great entertainment and are willing to pay for more than one streaming service to get the content they want.

The final verdict

At this point, Netflix is the better buy. Its consistent revenue and subscriber growth, steady path toward being cash flow positive next year, and resilience in the face of fierce competition are all factors making it a justified part of the FAANG gang.

AT&T, meanwhile, must spend years reducing its debt. This and its substantial dividend payouts, totaling nearly $15 billion in 2020, hamper the company's ability to invest in its business.

So for now, Netflix is the clear winner in this comparison.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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Netflix Inc (NASDAQ: NFLX) shares touched an all-time high on Wednesday after the company delivered another impressive earnings report. It added 8.5 million subscribers in the period and said it would no longer need to take on debt.

Despite record subscriber growth in 2020, which was aided by the coronavirus pandemic, Netflix bears continue to roar about the onslaught of competition the streamer is facing.

Over the last year or so, Disney+, Apple TV+, Peacock, HBOMax, and Discovery+ have all joined the streaming fray, and ViacomCBS's Paramount+ is set to launch in March. 

Streaming clearly reached a tipping point last year and the coronavirus pandemic has only accelerated the transition from linear TV to streaming TV that co-CEO Reed Hastings predicted several years ago. For Netflix, the question of whether the company has a sustainable competitive advantage with all the new competition entering the streaming arena bears asking, but after the latest report, there are a number of clear signs that Netflix does have an economic moat. Even better, it is widening.

Pricing power

Netflix said it would raise prices in the US in the fourth quarter, from $13 a month to $14 a month for its standard subscription. With that move, Netflix is now significantly more expensive than all of its competitors except HBOMax.

Data source: Company websites. Table: Author's own.

As you can see, most competing services are just about half the price of Netflix, and the only one in Netflix's range is HBOMax, though ad-free Hulu comes close. That's because, like Netflix, HBOMax has also earned pricing power as HBO has built a powerful brand in premium television over the last 40 years, and the network regularly brings home the most Emmy awards among networks. Netflix has managed to do something similar over its shorter history as its aggressive content spending strategy and efforts to offer something for everyone has paid off. 

Asked about pricing power in the recent earnings call, COO Greg Peters said, "We do think we're an incredible entertainment value, and we want to remain incredible entertainment value." He also explained how the company thinks about price hikes, saying: "OK, we've added more value in the service. Now it's the right time to go back to those members and ask them to pay a little bit more so that we can reinvest it and keep adding it."

Netflix prices its service to optimize its content spend, and that strategy and the quality of its content has allowed it to charge more than its peers, giving it a competitive advantage. It's worth noting also that Netflix as the streaming pioneer has a much larger subscriber base than any of its rivals, giving it another advantage as it can allocate its content spend across more members.

Increasing profitability

Cash burn has long been a problem for Netflix, but the company just told investors that it was very close to being sustainably free cash flow positive, forecasting break-even free cash flow for 2021.

Though cash flow has long been a challenge for the company as the nature of its business demands high upfront costs, on a generally accepted accounting principles (GAAP) basis, Netflix's profitability has significantly expanded in recent years. The company posted an operating margin of 18% in 2020 and expects to deliver a 20% operating margin this year. From there, it gets better as management projects an improvement of three percentage points each year going forward, giving the company a margin of 29% by 2024.

That along with its pricing power also indicates an economic moat in streaming. The debutantes are still trying to figure out a way to build out audience and generate a profit. Netflix, with the help of a long first-mover advantage, has been there for a while, and is pressing its foot on the gas pedal at will.

In addition to those strengths, the company's local content focus and global strategy also separates it from the streaming wannabes as it already has a large library of original foreign language content that drives international growth.

Video entertainment is a huge industry and it won't be monopolized. There's room for more than one winner in streaming, especially as the cable ecosystem continues to weaken, but Netflix remains the leader, setting the pace in the industry. Its competitive advantages are clear.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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