The Walt Disney Company After Fiscal Q2: Wondering If Wonderland Returns
Contributor since 2011 / 23871 Followers
Summary:
- Shares of The Walt Disney Company have come under further pressure following the release of its fiscal Q2 earnings.
- Margin pressure has spread beyond the direct-to-consumer streaming segment.
- Direct-to-consumer momentum is furthermore fading as well, in terms of commercial traction.
- Lower earnings, poor cash flow conversion and higher debt makes me very cautious about Disney stock, with no immediate triggers in sight.
EnchantedFairy
In November, I concluded that there was no fairy tale for shares of The Walt Disney Company (NYSE:DIS), as the company saw a tough end to the fiscal year 2022. While revenues were recovering nicely, margins were under pressure for some time, due to streaming, among others.
With many questions to be posed, I was not convinced, even as the company anticipated some sequential improvements into its fiscal 2023. Disney reported fiscal Q2 earnings yesterday which missed estimates, and they have not been received well by the markets.
A Recap
Walt Disney is a long term corporate success US story, although it has been impacted greatly by fierce competition and other threats to its business model. A $66 billion deal for Twenty-First Century Fox engineered in 2019 should have allowed the business to compete with Netflix, Inc. (NFLX), among others, but for now just added a lot of leverage to the firm, as the deal did not live up to expectations.
A $100 Disney stock pre-pandemic rose to a momentum driven high around $200 in 2021, after which shares fell back to the $100 mark in the summer of 2022, leaving investors with no capital gains over a period of seven years.
Pre-pandemic the company was a $70 billion business, with both parks and media networks both contributing about $25 billion in sales, as the company had an $11 billion studio entertainment and $9 billion direct-to-consumer business as well. Operating earnings of $14 billion translated into margins of 20%, with net earnings of $10 billion working down to $6 per share.
Revenues plunged to $40 billion in 2020, mostly as parks were closed, as 2021 revenues recovered to $67 billion, nearly approaching the 2019 levels. The pain during the pandemic and leverage taken on with the Twenty-First Century Fox deal added a lot of leverage, with net debt reported at $38 billion.
With earnings power pegged at $4.00-$4.50 per share over the summer, it was evident that earnings power was impaired and that net debt was substantial, amidst continued competitive pressures. In November the company posted its fiscal 2022 results with revenues up 23% to $83 billion amidst inflationary impacts and a full reopening of the business.
The issue is that adjusted earnings of $3.54 per share fell way short compared to my estimates, mostly as the company reported $4 billion in annual losses in its direct-to-consumer segment which was mostly comprised out of Hulu and Disney+.
Adding back the losses of the direct-to-consumer segment, I saw realistic earnings at $5.50-$6.00 per share if the company could break even on these activities as the company guided for $200 million in profit improvements on a sequential basis for the first quarter of 2023 within that segment. Trading at 16 times potential earnings, assuming that the business could boost earnings to $6 per share over time, I was very cautious as a lot of heavy lifting was still to be done, which furthermore was no easy task.
More Disappointments
After urging a cautious tone in the $90s in November, Disney shares have traded in an $85-$115 range ever since, as shares are down 8% to $92 at this point in time following the release of soft second quarter results.
In February, the company posted an 8% increase in first quarter sales to $23.5 billion which was about the good news with adjusted earnings down 7% to $0.99 per share.
The real issue were the soft second quarter results, as released in May. While revenue growth accelerated to 13% with sales reported at $21.8 billion, adjusted earnings fell 14% to $0.93 per share. This was in part driven by losses at direct-to-consumer activities, but mostly because margin weakness was spreading to media and entertainment activities and linear networks as well.
Free cash flows are hurt because of continued large capital investments, with net debt pretty flattish around $38 billion, as this debt load has been prohibitive to reinstate the dividend again after the company suspended it during the pandemic.
Given the trends observed so far this year, $3.50 per share adjusted earnings power in 2022 will likely come under more pressure, making a roadmap to earnings of $3 per share perhaps more realistic than a recovery to $4 per share, despite narrowing losses at the direct-to-consumer business.
This latter observation looks encouraging, but goes hand in hand with a decline in the user base as well, as lower investments (read losses) might hurt commercial traction as well, an indication that Disney is not able to effectively compete against other streaming giants.
Still Erring Cautious On Disney Stock
Given all of this, I am cautious about The Walt Disney Company stock, as higher interest expenses and continued margin pressure results in poor free cash flow conversion, even as substantial layoffs are announced in an effort to stem the tide.
Besides the impact of the pandemic, the expensive deal and leverage from the Fox deal, intense streaming competition, commentators believe that adoption of “woke” practices are self-inflicted wounds and hurt the business as well.
With the situation perhaps more challenging than was the case in November, when The Walt Disney Company shares traded at largely similar levels, I am extremely cautious here, despite the setback seen in today’s trading action, making it too early to get involved with Disney shares here.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
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