Here’s Why Disney Might Not Be A Good Bet Just Yet

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Trefis
DIS: Walt Disney logo
DIS
Walt Disney

After a 52% rise since the March 23 lows of this year, at the current price near $131 per share Walt Disney stock (NYSE: DIS) seems to have surpassed its near term potential. Disney stock has increased from $86 to $131 off its recent bottom, compared to the S&P 500 which increased by around 50% during the same time. With the stock being about 25% above the levels seen at the end of 2017, we believe that the stock could go down from here. Disney could see modest growth of about 16%-17% in revenues between FY2019 and FY2021, but that is likely to be more than offset by a sharp drop in margins, which could lead earnings to drop by close to 8% by 2021. Though the company’s streaming platform Disney+ is seeing healthy subscriber growth, this effect is likely to be offset by the uncertainty regarding the company’s traditional media, studio, and parks businesses functioning to full capacity anytime soon due to the recent surge in Covid positive cases in the US.  Disney’s P/E multiple is expected to hover close to its current level, thus providing Disney’s stock a potential downside of about 5% from its current level. Our dashboard Walt Disney Stock Rises 25% Between 2017 And Now But Currently Looks Overvalued has the underlying numbers.

 

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Some of the stock price rise between 2017-2019 is justified by the 26% growth in Disney’s revenues, which was mainly due to the acquisition of Fox and the consolidation of Hulu. This effect was partially offset by a 2.4% deterioration in profitability, as net income margin declined from 16.3% in 2017 to 15.9% in 2019. Margins shot up in 2018 due to a lower effective tax rate, but they fell in 2019 to below 2017 levels due to acquisition-related expenses and higher interest burden. On a per share basis, earnings increased by almost 10% from $5.73 in 2017 to $6.30 in 2019.

With the rise in EPS, the P/E multiple also increased from 18x in 2017 to 23x in 2019 as the market expected higher top and bottom line growth for the company following its acquisition of Fox and launch of its streaming offering Disney+ in late 2019. However, the P/E multiple fell in 2020 following the outbreak of coronavirus, only to recover to a certain extent over recent weeks following the Fed’s stimulus package. The multiple, which currently stands at close to 21, is unlikely to see much movement from here in the near term.

What’s The Upside Trigger For Disney?

With almost all major cities being locked down due to the spread of coronavirus, there has been a slowdown in economic and industrial activity. The ongoing lockdown of major cities and economic slowdown has adversely affected the company’s parks and resorts segment which has virtually seen a complete shutdown. Parks & Resorts segment has seen its share in Disney’s total revenue increase over the last 5 years, from 31% in 2014 to 38% in 2019, thus exacerbating the effect of the current crisis on the company’s top line. Additionally, lower spending power is also expected to lead to a drop in the company’s traditional media business and advertising income. With film shooting and releases being halted, the company’s studio business is expected to be adversely affected, with the acquisition of Fox not proving to be beneficial in 2020 so far. The gravity of the crisis was reflected in the company’s recently announced Q3 2020 (year ends in September) where revenue declined 42% y-o-y, with all segments except consumer products seeing a drop in revenue. Disney also reported a loss of around $2.61/share in Q3 2020 as against a profit of 0.98/share in the year-ago period. As expected, parks & resorts and studio were the worst affected divisions.

But the lockdown and home confinement of people has increased demand for streaming services. This is where Disney+ is proving to be a saving grace for Disney during this difficult time. Within just 9 months of its launch, Disney+ boasts of a paid subscriber base of close to 58 million, with the company’s total paid subscribers for its streaming services (Disney+, ESPN+, Hulu, etc.) is over 100 million. Thus, Disney+ has been a huge success for the company and has helped Disney tide over the current crisis. As the lockdowns are gradually lifted and people venture out for work, the demand for streaming is expected to see a moderate decline. But this is projected to be offset with the other traditional businesses like parks, resorts, and studios gradually getting back on track. However, the recent surge in Covid positive cases in the US could prove to be an impediment for Disney’s growth. If cases continue to rise at a faster rate and if another lockdown is imposed, the stock price could see a sharp decline. With the investors’ focus shifting to 2021 numbers, we project FY2021 to be a year where revenue growth enters the double-digit territory and earnings are likely to improve. The recent sharp rise in price is a reaction to the Q3 announcement, but in the absence of a clear picture with respect to the abatement of the coronavirus crisis, the stock price could remain volatile in the near term. Disney’s valuation by Trefis works out to about $125 per share, reflecting a potential downside of about 5% from its current level.

For further perspective of the streaming world, see how Disney compares with Netflix.

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