One Stock is Benefiting From The Recession

That stock is Netflix and it is one of the rare list of stocks that are trading near their 52 week highs. The stock price has doubled since reaching lows in October 2008.

One reason is that subscriber numbers are accelerating. In 4Q08, sub numbers grew 19% YoY from 16% YoY in 3Q08 and the midpoint of 1Q09 guidance points to another quarter of sub growth acceleration.

I could only arrive at one reason for this phenomenon and that is the millions of the unemployed are using part of their severance and unemployment checks for a bit of entertainment in the form of DVD rentals. I have several unemployed friends doing just that now. Most are foregoing visits to bars and restaurants and instead are sitting in front of their 50inch plasma TVs passing time watching movies. Several of them have subscribed to Netflix.

So what is happening that is causing the share price appreciation? In 4Q08:

1. Subscriber numbers that we talked about above accelerated 19% YoY due to a 40% YoY growth rate in gross subs (churn rate increased a few points).

2. Operating income grew 90% YoY

3. Gross margins improved 200bps and operating margins improved 400bps, the latter due to more efficient marketing spending and declining subscriber acquisition costs.

4. The company is buying back stock while most companies are holding off on share repurchases.

5. The model generated $51 million in FCF in 4Q and ended the year with $300 million in cash.

6. 1Q09 guidance was materially above Street expectations.

I must confess that I was never a fan of the Netflix model although I appreciated its acceptance. One reason is because I thought distribution of movies over the Internet would have reached critical mass already and competition from Amazon, Blockbuster and others would have stymied Netflix's growth. Neither has turned out to be the case.

The stock is trading at 24x '09 EPS but at a reasonable PEG of 1.06. So there is likely more upside to the shares, but given the history of this stock I would caution anyone from jumping in at these levels.