Bullish On Disney, But Average-In On Price-Decline Days

Summary:

• Disney’s recent earnings report generated positive price action, but the stock still has a long way to reach its $200 level from March 2021.
• CEO Robert Iger remains at the helm, focusing on cost-cutting and streaming growth to navigate industry disruptions.
• Disney’s Q4 saw strong financials with EPS growth and increased free cash flow, but linear networks remain a challenge, and debt is still an opportunity.
• Long-term investment in Disney is recommended, with a focus on averaging in on down days; based on a valuation analysis, price-per-share could hit between $155 and $175 in a couple of years.

The Walt Disney Company (NYSE:DIS) reported earnings on November 14, and the stock reacted positively. Finally, some good news on the price action, as the shares have recently trended higher.

Of course, not all is positive in the sense that the stock still has a long way to go to recapture that $200 level, which it last saw in March 2021. Back then was the story of the streaming pull-forward of value resulting from the rampaging SARS virus.

CEO Robert Iger is still at the helm, looking for a successor, and frankly, it wouldn’t surprise me if he stayed a little longer. I’d rather we finally move to the next chapter of leadership at this point, but it is what it is, and Iger certainly has made some good choices along the way (Pixar/Marvel, all of that).

I’ll go over the most recent quarter. For the stock: I haven’t changed much, it is still a long-term holding, but I’m not sure recent price action will necessarily stick. The good news I mentioned at the top might retreat a bit, but my hope is a new higher base is formed. I would add opportunistically to a long-term position, and I should note I do trade around my long-term shares, and in fact sold out of my trading position upon the follow-up strength of the report (by the time this is published, I may very well be back in on the short-term account).

Disney really has become an interesting story, as it is fascinating to observe management respond to the continual disruptive wake that Netflix, Inc. (NFLX) unleashed upon the industry after Reed Hastings opened a Pandora’s box that seemed to affect every media concern save for his. This is the double-edged sword of being interesting – the company still has a ways to go in terms of solidifying strategies that offer solutions to the stranglehold that linear decay continues to wield over the company and the stock.

Admittedly, whereas before it was always a simple thing to recommend Disney in a buy-and-forget manner, just another example of the proverbial core holding, investors must understand that even once Iger rights the ship (we’ll think positive here), the challenges will continue to come.

I last wrote about Disney in August. I was overly cautious at the time on the short-term end, as the stock seemed to technically strengthen and show support following the piece. Strength should assert itself over the next few years, but I think we have no choice but to remain cautious over shorter-term time periods. It’s a volatile market, after all, and charts and macro can change on a dime (as well as audience reaction to film/streaming slates). Also, there is the concern of valuation, which I will go over based on guidance given by management: the short story there is the stock potentially could rise well above $150 in the next couple of years based on a conservative valuation approach, but I expect the stock to fare perhaps even better by beating expectations (no guarantee on that, so keep in mind the conservative approach for full context).

The Fourth Quarter

Right at the top, we have a nice round of earnings appreciation. For the fourth quarter, adjusted diluted EPS was $1.14 versus $0.82 a year ago, and for the full year EPS was $4.97 versus $3.76. The $1.14 figure beat consensus by a few pennies.

I’ll actually jump to debt because I’ve been thinking about that more lately, as media companies being disrupted by Netflix, Inc. (NFLX) have been contemplating shuffling assets, with the latest example being Comcast Corporation (CMCSA) and its cable channels. Long-term debt stands at $38 billion, with interest expense for the full fiscal year calculated to be roughly $1.2 billion, the latter basically the same as last year. The previous debt level was listed as $42 billion. There’s an opportunity here, I think, to increase deleveraging.

Free cash flow is something Disney always likes to promote when it’s doing well (and if it isn’t, Disney, like any other company, always likes to counsel us to just be patient), and the cash was certainly doing well over the last year. For Q4, the stat jumped 18% to $4 billion; for the full year, it went up 75% to well over $8 billion. Roughly a little over $4 billion of that free cash was applied to dividends and repurchases. A positive development, as Iger wants the company to return to some normalcy and reward shareholders for their aforementioned patience as he continues to turn the ship around.

Speaking of ships, the company highlighted on its conference call that there will be more cruising vessels added to the parks portfolio and that the investment in parks is going well – you will recall that the company plans to invest $60 billion over ten years on the premise that the core business from which all else flows will generate high returns on capital.

Then, we have the all-important streaming stats.

Total direct-to-consumer, including all services, generated a profit of $250 million versus a $400 million loss. One thing driving this was lower marketing costs for D+. Disney has been a cost-cutting story since Iger replaced former CEO Robert Chapek. This will be the challenge: find a way to continue cost-cutting while at the same time yielding more content per billion-dollar spend.

The reason for this is simple to understand: churn must be reduced, subscriber count must increase (even if only in a steady, incremental way), and advertising impressions must expand. D+/core subscribers – that is, minus Hotstar branding – increased to 122 million from 118 on a sequential-quarterly basis. D+/core ARPU increased eight pennies to $7.30… a modest rise, but as long as it is not going down, we’re doing okay, especially as the expectation is for the ad business to go higher. Hulu SVOD (which excludes the live-TV segment, which really isn’t a notable business) saw its subscriber base remain flat at 47 million; ARPU also went down a percent to $12.54. Hulu needs some marketing attention, perhaps.

Linear networks division continues to be the problem. Quarterly revenue down 6% to $2.4 billion, operating income down 38% to just under $500 million.

This puts pressure on Disney to increase streaming profits, reduce debt, and expand opportunities at theatrical. All the while increased capital spending at parks hopes for generous returns to fuel the ecosystem and hedge against any risks of a downturn, either internally made or of external origin.

Brief Analysis

Where does this leave Disney?

Bob Iger is pretty confident about the future of the company. So am I. But for the stock to finally be free of its technical rut, catalysts will be needed…certainly fundamentally, and possibly transformative via asset change-up.

In terms of asset switch, no, I don’t mean that the company will buy anything big and transformative…most likely it would either be smaller companies or, even more likely than that, investments, such as the one with Epic Games.

That’s on the buying end. But what about being a seller?

I don’t think Disney will unwind any of its past acquisitions (I’m talking the Pixar-type buys), certainly. However, that aforementioned spin-off of cable channels at Comcast does have me thinking. I definitely find it possible that either Iger or the next CEO (will there ever be a next CEO?) will look at the company’s cable-channel portfolio and see what might make a good sale or spin-off candidate. My speculation, of course, but Comcast’s announcement ups the odds in this area in my opinion.

I am anticipating higher dividend payments over time, and even higher repurchases, albeit probably incrementally at first, as the company has to weigh macro conditions and investment in capex. The higher dividends will be key because the stock has become an investment idea that almost demands payment for patience…as I alluded to earlier, it’s a long way back to $200 (and beyond).

There is an exciting potential catalyst coming up in the next couple of years with the launch of the ESPN-flagship product, which will essentially be a streaming version of the linear channel; as it exists now, ESPN+ is not a full replication of the content seen on the linear version. Also, Iger said in the conference call that betting will also be included in the flagship. This latter opportunity holds promise as a significant revenue stream, in my opinion.

Valuation

Disney offered guidance for the next couple of years.

Fiscal 2025 is supposed to feature high single-digit EPS growth. That should be around 8% one might assume, but I’m going to step down a point to be conservative. The company did an adjusted $4.97 this past year, so 2025 should see at least $5.32 EPS (adjusted) if everything runs smoothly (i.e., no macro problems, no company-specific issues).

Free cash flow is expected to come in at $7 billion, with $8 billion in cap-ex. There will be $3 billion of stock repurchases. Free cash flow in 2024 was $8 billion, cap-ex was $5 billion, stock-repurchase activity was $3 billion, and the dividend paid was $1.4 billion. Basically, the company is forecasting a conservative stance that is favoring parks…I don’t see much growth in the dividend, and we know buybacks will be flat. This in my opinion works in the company’s favor because it believes capital returns will be optimized by parks investment. Presumably just about all the surplus cap-ex compared to 2024 will be allocated to that division.

Based on 7% growth, the current P/E (as of this writing) is 21. Expensive compared to the sector median currently pegged at 13, but much less expensive compared to the five-year average reading for DIS itself (which, of course, included the height of the SARS-2 outbreak).

Let’s now look at 2026. There is an expectation for “double-digit growth.” No qualification to it, just “double-digit growth.” Let’s call it only 10%, no more. So, we get $5.85. Forward P/E drops to a 19-handle before we get to the decimal, so let’s say it drops a point to 20. Operating cash flow is expected to be at least $16.5 billion. I expect free cash to be around $8 billion, not much more. So, again, don’t think too much about the dividend or share buybacks just yet (at least in terms of growth; they will still be there, of course).

EPS is supposed to grow double-digits in 2027. That brings us to a P/E of just under 18, with $6.43 in adjusted EPS. No mention of what cash flow should be like, but I am anticipating double-digits there as well. I’ll assume $9 billion in free cash.

You can play with different P/E scenarios and assign whatever hypothetical premium you want, but at $6.43, the future price could end up at possibly $155 if the P/E was something like 24, which would probably be a premium to the market.

Assuming expectations are beaten along the way and the stock technically improves, assuming multiple expansion on sentiment, the stock could be anywhere between $155 and $175.

Being conservative though, and with the stock at a current price of roughly $115, and with the S&P 500 currently strong, one might consider wanting a better margin of safety with Disney, especially given some risks.

We all know the common ones – market volatility, Netflix competition – but it should be noted that Disney requires a strong theatrical slate to keep its cross-promotional synergies going, so it is something to keep in mind, especially considering that the company sometimes sees lackluster box-office grosses (e.g., Marvel’s The Immortals). The parks may see a downturn in attendance for any number of unforeseen events, whether weather-related, virus-related, or even attraction-related – on that latter count, we all recall the shuttering of the very expensive Star Wars experience. Another risk many might not think about immediately: Bob Iger may be distracted by looking for a successor; he probably is extremely focused on getting it right so he can guarantee his corporate legacy. The problem is, you only have so much focus capital, and I want it allocated toward the area of highest return…at some point, he should just make the best decision he can as far as a successor goes, rely on the board as much as he can, and invest his time in solving the linear problems and in strengthening streaming assets.

Conclusion

As I said near the beginning, DIS should be looked at as a long-term investment idea which may have more risk attached to it than in past years given linear declines. At around $115, pullbacks are very useful in entering a position, especially if the stock retreats to $100. Not guaranteed to happen, though, as price action seems to have firmed up. The best bet here is to average in on down days, focusing on big drops in share price. The company has a great collection of assets and a significant opportunity to beat expectations in the next few years as streaming increases profitability.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of CMCSA, DIS, NFLX either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

In addition to long-term positions of DIS and NFLX, I trade short-term positions in those names in a separate account. CMCSA I am currently trading as a short-term position.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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