Walt Disney (DIS:NYSE) used to be one of those stocks that even cautious investors could rely on. For the past 40-odd years the share price has steadily chugged higher, and investors have been repaid for their faith with a reliable stream of dividends year after year.

Yes, there have been stumbles along the way, even the most dependable stocks falter now and then. Disney floundered during the internet bubble in the late 1990s, again during the great financial crisis, and now, the company is once more facing a crisis of Hollywood epic proportions.

Since March 2021, the stock has lost almost 60% of its value, with the return of former CEO Bob Iger failing to revive its fortunes despite some initial excitement. To put the situation another way, in just two and a half years Disney has seen something like $220 billion of shareholder value vanish.

That’s quite the trick, one even The Sword and the Stone’s wizard Merlin might struggle to match.

WEB OF BUSINESSES

Disney’s business used to be straightforward – produce a regular stream of hit movies and use them to lure millions of holidaymakers to its theme parks. And it quickly latched on to the idea that it could re-release its catalogue of classic cartoons at cinemas every seven years or so, tapping into to a new generation of kids to wow.

But the internet age has not been kind. Children have so many more ways to entertainment themselves these days, spending hours on connected gaming devices with their mates, or watching a deluge of streaming TV apps.

Today’s kids are also a more knowing bunch, and where once the thought of meeting Mickey in the flesh at the Magic Kingdom would have drawn cheers and looks of wonder, the experience doesn’t carry quite the same cachet as it once did.

Disney has adapted to the digital challenge in several ways, spending billions of dollars on extra content (Star Wars, Marvel) and launching its own streaming app Disney+. This has had limited success and it is still its tried and trusted theme parks that are carrying the business.

Reports show that attendances at everywhere from Magic Kingdom to Walt Disney World to Universal Orlando are down in 2023. The thinking is that while high prices during a cost-of-living crisis have played their part, there is also a normalising effect going on in the wake of the bumper crowds as lockdown restrictions were lifted after more than a year of enforced stay at home holidays.

Disney’s Parks, Experiences and Products business (DPEP) is generating much higher profits in fiscal year 2023 (to end Oct) than it did in fiscal year 2019, according to Moffett Nathanson analyst Michael Nathanson. The analyst forecasts $12.3 billion from DPEP this year, up from $9.6 billion in fiscal 2019, stripping out the Pandemic-impacted years in between for a cleaner comparison.

The trouble is Disney’s media arm is in turmoil as its linear TV cable arm haemorrhages subscribers and the streaming business continues to lose money. There is a very real sense that something is always going wrong at the House of Mouse.

After a record fiscal 2018, Disney had a near-record year in fiscal 2019 where everything was going right. Its parks business was booming while its film studio was churning out blockbuster after blockbuster, propelling Disney’s box office revenue to an all-time $11.1 billion record.

Roll forward a few years and it’s clear that box office income is failing to march past levels in a post-pandemic world, while streaming service Disney+, once seen as the answer to death of cable TV fears, continues to run up losses and subscriber growth is now on the back burner as investors focus on streaming profitability.

Disney’s latest earnings report (9 August) got a mixed response from analysts and investors. There was progress under the returning Bob Iger. This included cost-cutting and a gradual move toward streaming profitability, including plans for a new ads-backed pricing tier and crack down on streaming account sharing, ripped straight from the pages of the Netflix (NFLX:NASDAQ) playbook.

But there were challenges also, such as further declines in the linear TV networks business, and limp box office business, particularly from its Marvel Cinematic Universe. Kicking off the year with Ant-Man and the Wasp: Quantumania, the film grossed less at the box office than almost every other Marvel Studios movie with its takings coming to just $476.1 million, according to reports, half of which is retained by cinemas.

While the shares briefly responded well to the results, enthusiasm evaporated faster than Marvel creation Quicksilver.

INVESTOR RETURNS HAVE COLLAPSED

One of the biggest problems for investors is that Disney continues to spend increasingly vast sums while the return on that investment gets worse. Operating expenses have nearly doubled since 2017 to $76.2 billion in fiscal 2022 yet return on capital employed has shrunk from 18% (2017 and 2018) to low single digits – 3.7% in 2022.

Operating margins have gone from 25% to 7.9% last year, and net income is barely half what it was a decade ago. This decline is one of the best arguments for why Disney stock has shown weakness. Return on equity has gone from 24.2% in 2018 to 3.5% last year.

Disney is now betting $60 billion in a decade long refresh of its theme parks and cruises. It is a strategy that has split analyst opinion, with many offering their backing, but others wondering when investors will see a return on this enormous outlay.

Bank of America analyst Jessica Reif Ehrlich remains a key Disney bull, citing ‘new areas of optimism,’ including new management cost savings forecasts of more than the $5.5 billion, and targets for Disney+ subscriber net additions to accelerate in the current fiscal fourth quarter.

Others are more wary. Macquarie analyst Tim Nollen summarised the latest results with a note to clients headlined, ‘So much going on, but not much change to numbers.’

‘We believe in long-term success of streaming services, including ESPN, as well as the studio and parks franchises, but we see too many near-term issues to support a more constructive view.’

Other analyst worries include rising Disney+ prices while content gets reduced, not exactly a winning message to potential new subscribers. ‘Even if the severe price/value shift is accepted by consumers, it’s still not clear if the rate of direct-to-consumer profitability improvement will more than offset the rate of linear profitability attrition,’ said TD Cowen‘s Doug Creutz, which he estimates at more than $2 billion year-on-year in fiscal 2023.

Shares saw a promising opportunity in the stock at the end of last year, which is why Disney was one of our Best Ideas for 2023. The stock surged early in 2023, prompting us to reassess that, having jumped 26% on our original buy idea, the ‘benefits from the restructuring have now been priced into the shares while the challenges faced by the streaming business remain a risk’.

Since then, Disney shares have slumped, wiping out all those gains and more, demonstrating the merits of locking in profit.

SHOULD YOU BUY DISNEY?

There are analysts that claim that Disney stock traditionally trades at a 20% to 25% premium to the S&P 500. The stock’s price to earnings multiple for fiscal 2024 is about 16, versus the S&P’s approximate 20-times rating, but such a comparison doesn’t necessarily consider the structural changes in the way we are all consuming TV and films in today’s digital world.

Disney undoubtedly has a collection of fantastic brands, but so does healthcare firm Johnson & Johnson (JNJ:NYSE) – Johnson & Johnson Baby Lotion, antihistamine Benadryl, pain relief drug Tylenol. Yet the healthcare company has vastly better return on capital, return on equity and operating margins than Disney (11.7%, 17.4%, 16.4%), and the shares are cheaper, on 12-month rolling PE of 14.5, Stockopedia data says.

In Shares opinion, there is anything but a compelling reason to own Disney shares right now, and we believe there is better value to be found elsewhere on the stock market.

‹ Previous2023-10-05Next ›