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Time to End the Love Affair With Netflix, Inc. (NFLX)

Netflix, Inc. (NASDAQ:NFLX) is somewhat of a cult stock. Indeed, the company has not made a sizable profit for the last two years, but yet, the stock price keeps rising. However, there could be some gaps starting to show in the company’s strategy.

For a start

Netflix, Inc. (NASDAQ:NFLX)First off, the company’s margins. Netflix, Inc. (NASDAQ:NFLX)’s gross margins have risen from 61% in the first quarter of 2011 to a high of 74% during the last quarter of 2012. However, margins have now fallen back to 70% as the company struggles to drive revenue higher. On a net basis, margins have deteriorated even more, falling from 8.4% during the first quarter of 2011 to an average of 0.5% during 2012, but then ticking slightly higher to 1.5% this year.

In comparison, close peers Twenty-First Century Fox Inc (NASDAQ:FOX) and Time Warner Inc (NYSE:TWX) have seen their gross margins stabilize at 35% and 43% (in fact, Time Warner’s margin has increased slightly from 43% to 44% from 2011 to 2012) for the past two years, respectively. Additionally, Twenty-First Century Fox Inc (NASDAQ:FOX) and Time Warner Inc (NYSE:TWX) have kept net margins steady at approximately 10% for the same period.

Costs are rising

Secondly, Netflix, Inc. (NASDAQ:NFLX) has seen its cost of sales and interest costs rise significantly faster than revenue, stunting growth.

March 2011 June 2011 September 2011 December 2011 March 2012 June 2012 September 2012 December 2012 March 2012 June 2012
Revenue $718,553 $788,610 $ 821,839 $ 875,575 $869,791 $889,163 $ 905,089 $ 945,239 $1,023,961 $1,069,372
Revenue Indexed 100 110 114 122 121 124 126 132 143 149
Cost of Sales $438,151 $489,978 $536,617 $575,155 $623,933 $643,428 $662,638 $695,867 $726,863 $753,525
COS Indexed 100 112 122 131 142 147 151 159 166 172
Interest Cost ($4,865) ($5,303) ($4,915) ($4,942) ($4,974) ($5,006) ($4,990) ($5,016) ($6,740) ($7,528)
Interest Indexed 100 109 101 102 102 103 103 103 139 155

Figures in $U.S. millions except for indexation

On an indexed basis, revenue has grown 21% over the last five quarters, while cost of sales has grown 42% and interest costs have only expanded 2%. Still, the rapidly rising costs are a cause for concern, especially when it comes to profitability.

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