EnchantedFairy
Shares of The Walt Disney Company (NYSE:DIS) have fallen to new lows, even as the market has seen a snap higher following lower inflation numbers, leaving the door open for a less aggressive stance by the Federal Reserve.
In the summer of this year, I concluded that Disney was still a mixed bag, even as shares were cut in half already from a high of around $200 in the spring of 2021. The share price and operating performance have been mixed for years, as park performance was still off its peak, while the streaming war was an intensive and costly battle.
Some Background
Walt Disney is a long-term U.S. corporate success, yet one which has been impacted by fierce competition and other threats in recent years. To offset the changes in a competitive (television) landscape, Disney announced a $66 billion deal for Twenty-First Century Fox, a deal which only closed in 2019 in order to compete with the likes of Netflix (NFLX), among others.
Being a $100 stock ahead of the pandemic, shares rose to $200 amidst excessive optimism in 2021, after which shares were back to $95 in July of this year, leaving zero capital gains over the past seven years.
The business generated $70 billion in sales ahead of the pandemic, with parks and media networks each contributing about $25 billion in revenues, complemented by an $11 billion studio entertainment and $9 billion direct-to-consumer segment. The company posted operating earnings of $14 billion that year, net earnings of $10 billion, and adjusted earnings of nearly $6 per share at the time.
Of course, the 2020 results were not indicative, as park revenues plunged, offset in part by higher media network revenues and a huge increase in direct-to-consumer segment. The mix resulted in adjusted earnings down to just $2 per share, while net debt ticked up to $40 billion.
2021 revenues rose by a modest 3% to $67 billion, as the pace of the recovery was not spectacular, with adjusted earnings up minimally to $2.29 per share and net debt still reported at $38 billion amidst continued headwinds from the pandemic. In May, the company posted a 29% increase in sales in the first half of the year, with revenues up to $41 billion. This came amidst the return of the park business, yet the issue is that earnings were only coming in at $2.14 per share, for a run rate of $4 per share. This is down a third from pre-pandemic earning numbers, amidst losses at the streaming business, quite shocking as net debt remains stable at $38 billion.
With shares trading at $95 in July and earnings power seen at $4.00-$4.50 per share, it is clear that all these changes are not helping Disney here and that long-term earnings power has been impaired. Political discussions, or better said involvement, changes in the leadership, and net debt all create challenges. A potential revival of the pandemic, or competitive pressures might easily hurt the business, let alone if we factor in the impact of emerging inflation at the time, leaving me quite cautious.
What Happened?
By mid-August, when Disney released the third quarter results, shares had rallied to the $110 mark. Revenues rose 26% to $21.5 billion with growth in sales and a profit recovery driven by the park business, offset by lower profits at the media and entertainment business, as the company posted a twenty-nine cent increase in quarterly adjusted earnings to $1.09 per share with net debt stable around $38 billion.
The shock was seen in November as fourth quarter revenue growth slowed down quite dramatically. So while full year revenues rose 23% to nearly $83 billion, fourth quarter revenues were up a mere 9% to $20.1 billion. While this is normally a softer quarter, the results were not impressive as quarterly earnings were down seven cents to $0.30 per share. This makes that even as full-year adjusted earnings rose to $3.54 per share, they are falling way short compared to my run rate estimated this summer, as net debt was reported at $37 billion.
If we look under the radar, we saw a 3% fall in revenues for Disney’s media and entertainment distribution business to $12.7 billion, on the back of declines in linear TV and lower content and licensing sales. This was offset by a 36% increase in Disney parks, experience, and products segment with revenues reported at $7.4 billion.
These parks and related activities posted a strong increase in operating earnings to $1.5 billion. Media & entertainment earnings were cut by more than 90% to less than a hundred million as linear networks remain incredibly profitable, offset by losses at the direct-to-consumer segment more than doubling to $1.5 billion, that is for a single quarter.
What Now?
The truth is that Disney’s results in the second half of this fiscal year fell short of my expectations. After all, earnings only came in around $3.50 per share (even on an adjusted basis), falling way short of my $4 per share estimate, or, better said, hope. Hence, the current multiple is quite elevated as leverage is substantial, although it remains a small concern.
Amidst all of this comes the real question, what profitability looks like once Disney is able to halt the losses at the direct-to-consumer segment (read Hulu and Disney+). After all, that specific segment racked in $4 billion in losses this year, equal to more than $2 per share here, as otherwise, earnings might trend closer to their historical $5.50-$6.00 per share range. The company sees a $200 million sequential improvement in that segment in the first quarter of 2023, driven by price hikes, while targeting profitability in 2024. Cash flow conversion is likely softer amidst elevated capital spending seen this upcoming year, to levels near $7 billion.
Once achieved, that could unleash potential at 16 times earnings for such a quality name. Yet, the truth is that Disney’s recent performance is utterly soft, making me still a patient investor willing to wait the situation out.
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