Disney: Valuation Overshoots Performance, But Is It Still A Buy?

Walt Disney was an entrepreneur extraordinaire, a visionary, and a creative genius. The company founded by Walt and his brother Roy, The Walt Disney Company (DIS), was headed by an exceptional CEO, Bob Iger, for fifteen years.

Under Iger’s leadership, Disney acquired Pixar, Marvel Entertainment, LucasFilm, and 21st Century Fox. During his tenure, the company’s market cap increased from approximately $50 billion to over $341 billion.

Additionally, the success of Disney+, with the platform gaining 86 million subscribers since November of 2019, has been the talk of the investment community.   

However, the pandemic has resulted in closures of Disney’s theme parks, the suspension of the company’s cruises and theatrical shows, and delayed distribution and production of movies and television content. Of course, this led to a drop in revenue and EPS. And yet, the share price skyrocketed.  

What Should We Make Of This?

The following charts provide a record of Disney’s revenue and EPS over the last two fiscal years. 

Note that revenue increased significantly during Q3 2019, the first period that reflected a full quarter of performance from the 21st Century Fox acquisition and the full consolidation of Hulu. However, revenue has fallen since Q2 2020 due to the negative effects of the coronavirus pandemic. 

Now, take a look at the following chart, which provides a review of quarterly EPS.  

Note that although revenue skyrocketed in Q3 2019, EPS recorded a significant decline. Unfortunately, lackluster EPS numbers are not the only concern.  

The acquisition of 21st Century Fox came with a significant increase in the debt load. Debt stood at roughly $17 billion in 2018, ballooned to $38.1 billion in 2019, and now totals nearly $53 billion.

The increased debt and the damage wrought by the pandemic resulted in Disney suffering a debt rating downgrade. S&P dropped Disney’s long-term debt rating to BBB+/negative outlook while Fitch lowered the debt rating to A-/negative outlook.   

The former’s rating places the firm’s debt three notches above junk. Consequently, Disney’s cost for debt servicing will be increased.

Now consider that as EPS fell and debt increased, the share price skyrocketed.

On top of this, the loss of Bob Iger should not be taken lightly, and Disney’s move to eliminate the dividend, while prudent, is also a negative in terms of the stock’s appeal to some retail and institutional investors. 

It Isn’t Time To Wave Goodbye Just Yet

This is not to say that Disney is a poor investment or that long-term investors should sell their shares. 

The problem isn’t the company, it is the share price. How can you justify a 84% increase in the stock’s price since 2018 knowing EPS was falling prior to the pandemic? 

Some will point to the incredible performance of Disney+ as a reason to believe the shares will surge once COVID restrictions are relaxed. After all, the company forecasts 230 million to 260 million subscribers by the end of FY 2024.  

However, the Direct-to-Consumer and International segment lost over $2.8 billion last year, and management has repeatedly stated that the streaming services will not show a profit before 2024.

When the shares sell at a reasonable valuation, Disney is an outstanding investment.  However, Disney cannot be considered as trading near fair value by any acceptable metric.

The prudent thing for investors to do might be to remain on the sidelines until Disney’s valuation converges to more realistic levels.

What Does Wall Street Think?

Analysts on the Street remain bullish with a Strong Buy consensus rating based on 19 Buy and 5 Hold recommendations. The average analyst price target of $206.59 implies around 8% upside potential from current levels over the next 12 months. (See Disney stock analysis on TipRanks)

Disclosure: On the date of publication, the author was long Disney shares.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.