The Walt Disney Co. (DIS, Financial) is at the beginning of a new chapter in its fairy tale story, which has taken investors on a rollercoaster ride with share price gains of approximately 5,800% since its initial public offering in 1957. This next chapter in the company's story involves the return of Bob Iger as CEO, albeit temporarily.
Often CEOs can be basked in a glow of grandiosity, but I believe Iger does deserve a lot of credit. Throughout his tenure as chief executive (between 2005 and 2020), Disney racked up a share price gain of 438%. Now one may put that down to luck, but he made some incredible moves such as acquiring Pixar in 2006 (headed up by the late Steve Jobs) and Lucasfilm from George Lucas in 2012. In 2023, Iger has targeted $5.5 billion in cost savings.
In this discussion, I will break down Disney's brand power, its financials and valuation. Let's dive in.
Disney's brand power advantage
Many people underestimate the power of a brand, but I believe this is Disney's competitive advantage. In a world of commodity products, content and programming, brands stand out. In fact, I would make a bet that you interact with at least one of Disney's brands at least once a month. Now you might be thinking, "I don't watch Disney cartoons," but check out the full plethora of brand selections below and my meaning will become clear. In addition to Lucasfilm and Pixar, Disney owns Marvel Studios and a number of other brands.
Now, of course, this all compounds on top of all the classic Disney films such as "Snow White," "Cinderella," "The Little Mermaid," "The Lion King," "Aladdin" and many more. These story brands are not just one-hit wonders, but effectively an ongoing cash cow. For example, the first "The Little Mermaid" movie aired in 1989, with a sequel in the year 2000, a prequel in 2008 and a remake coming later this month. Additionally, the beloved characters from these stories are effectively the intellectual property of Disney.
Marvel is also a tremendously special brand in my opinion, even more so than the core fairy tale Disney characters. However, this brand power was not always as obvious. In fact, according to a 2023 interview with Iger, he first mentioned to Jobs about potentially wanting to acquire the brand. Jobs asked, "What do you want a comic book brand for?" The story goes Iger then listed out all the incredible Marvel characters, which include Spider-Man, X-Men, Iron Man, Thor, Captain America, the Avengers and many more. At the time, many of these character brands were still associated with cheesy movies from the 1980s. However, since the Marvel Cinematic Universe was launched in 2008, its studios have racked up a total of 26 Oscar nominations with its blockbuster movies generating billions of dollars.
It is important to note Disney only owns the merchandising rights for Spider-Man and not the film rights (which are owned by Sony (SONY, Financial)). The good news is Disney has previously signed a content licensing agreement with Sony that will bring its movie releases to Disney+, such as the Spider-Man franchise, with the exception of "No Way Home" for now.
Other franchises, such as Avatar, have also been tremendously successful with "Avatar: The Way of Water" (2022) generating a staggering $2.3 billion in box office sales, becoming the third-biggest movie of all time globally according to Box Office Mojo. I also discovered eight out of the top 10 biggest movies of all time were produced or owned Disney (via brands such as Marvel, Fox, Lucasfilm, etc). As a bonus, Disney even benefited from the merchandise sales related to the "No Way Home" Spider-Man movie, despite the film rights being owned by Sony.
Disney is quick to leverage the blockbuster success of its movies by expanding brand touchpoints to its products and parks. For example, the company launched a "World of Avatar" experience in 2017 at Disneyland and aims to expand this further in 2023, with the help of James Cameron, the original director.
Many value investors aim to purchase cheap stocks, but brand power can often be one of the most valuable intangible assets, which is often overlooked. Building specific themed areas such as Avatar World is extremely powerful as each engagement with the brand increases connection with consumers. For instance, those who watch a Disney movie are more likely to visit theme parks, etc. Iger has made it a strategic priority to continually invest in brands throughout 2023 and into 2024, which I believe is a solid strategy.
Solid but mixed financials
In February, Disney reported steady financial results for the first quarter of fiscal 2023. Revenue of $23.51 billion beat analysts' forecasts and increased by 7.76% year over year. This growth rate has slowed down from the 8.72% reported in the fourth quarter of 2022 and 26.33% in the third quarter. However, this trend was expected due to the macroeconomic slowdown and is in line with almost every company I have covered recently. Its earnings per share was 70 cents, which beat analyst forecasts by 14 cents and increased by roughly 15.94% year over year.
In the chart below, you can see Disney's revenue has dipped in a number of quarters (some of which has been driven by seasonality), but came back stronger in the first quarter, which is a positive sign.
Disney revenue (Chart created by author)
Further, I have broken down Disney's sequential or quarter-over-quarter revenue growth rate. The company reported solid growth between fourth-quarter 2021 and first-quarter 2022 of approximately 17.84%. This then dipped slightly to 11.69% and even went negative by the fourth quarter of 2022 (ignore table offset). I was happy to see revenue bounce back, though, in the first quarter of 2023 with a strong 16.63% growth rate.
Disney revenue (Chart created by author)
Parks bounce back
Breaking down revenue by segment, the Parks, Experiences and Products segment had a strong quarter, with a massive 21% year-over-year increase in revenue to $8.7 billion. Surprisingly, this was achieved by actually reducing the capacity at the parks by around 20% compared to 2019 levels, in order to enhance the guest experience. This is counterintuitive, but it does make sense as often there is a set of customers who wish to visit the park, but only go on less busy days, which boosts the experience overall. In fact, if Disney cites it is at maximum capacity during certain holiday periods, this will likely build greater demand for the parks, due to the law of scarcity.
First-quarter earnings report
Overall, Disney's park attendance in aggregate was "pacing" above the prior year and its per capita guest spend grew, according to the earnings call. This was driven by growth at Disneyland Paris and increased royalty revenue from Tokyo Disney. Its Shanghai park did show weakness, as it was closed for a month during the quarter. However, I believe this park will bounce back as China has lifted its hard lockdown policy and the International Monetary Fund has forecast a huge 5.2% gross domestic product growth rate, up from 3% in 2022.
The segment's operating income increased by a solid 25% year over year to $3.1 billion. This was surprising given the inflationary environment, but was a positive overall and shows the pricing power or magic of the Disney brand.
Disney Cruises also bounced back with higher occupancy. Further, its newest ship, "Wish," reported high occupancy.
First-quarter earnings report
Media and entertainment challenges
Moving on to the Media and Entertainment Distribution segment, the company reported mixed results with a 5% dip in linear networks revenue, though its direct-to-consumer revenue increased by 12.8% year over year and its Content Licensing segment rose by 4.19%.
First-quarter earnings report
The real pain was felt in the operating income, which declined by about $800 million. This was driven by higher overheads in the content licensing segment in addition to a substantial increase in operating losses for Disney+, which was partially offset by strength in ESPN. I believe the sports segment gives Disney a competitive advantage against companies such as Netflix (NFLX, Financial), though Amazon (AMZN, Financial) Prime Video's "Thursday Night Football" has proven to be tremendously successful.
First-quarter earnings report
Subscriber growth is the lifeblood of any streaming business and, in this case, I was pleased to see Disney+ has continued to generate steady growth with a 20.3 million increase in subscribers year over year. This is a major achievement, as even Netflix has previously reported subscription slowdown and even losses, though its series of initiatives related to password sharing and ad-supported services has helped it bounce back. Disney is already ahead of the curve and learning from Netflix's mistakes in this regard as it introduced an ad-supported service at the end of December.
First-quarter earnings report
Netflix is still the market leader in streaming with 230 million paid subscribers, but Disney+ is catching up with a total of 161.8 million subscribers if we include the 57.3 million from the India-based Hot Star service. Granted, Hot Star did report a subscriber loss from the 61.3 million reported in the prior quarter, but this was still up from the 45.9 million reported in the prior-year quarter. Given the population in India, 1.4 billion people, I believe the platform has a huge runway ahead.
Great investors such as Warren Buffett (Trades, Portfolio) believe great brands have a “share of mind” with the consumer. Examples include Coca-Cola (KO, Financial), Apple (AAPL, Financial) and See’s Candy. In Disney’s case, the power of streaming brand characters right into the living rooms of households boosts that connection even more. Buffett sold his 5% stake in Disney back in the 1960s. He later said it was a “huge mistake” due to its brand power.
Moving onto Hulu (of which Disney owns a 66% stake), that adds another 48 million subscribers, bringing the total to 209.8 million subscribers. Let's also not forget ESPN+ (Disney owns 80%), which has 24.9 million subscribers, up 16.9% year over year. Therefore, if we bring everything together, we get a total of 234.7 million subscribers. This means Disney actually has slightly more subscribers than Netflix (if we include all brands). Granted, the part ownership makes a difference, but given most people assume Netflix is the dominant market leader, these calculations debunk this belief.
$5.5 billion in cost savings targeted
As mentioned previously, Disney is targeting a staggering $5.5 billion in cost savings. This includes about $3 billion in savings related to content spend over the next few years, with the majority expected to be realized by fiscal 2024, according to the earnings call. In addition, management expects $2.5 billion in selling, general and administrative and other operational cost savings, with 30% coming from reducing labor costs. Disney has announced plans to lay off 7,000 workers, with the first 4,000 employees let go in late April. I do not think this move is great for the company culture, but it is a necessary evil.
Disney presentation
Management has also announced plans to introduce a dividend by the end of 2023, which I believe will attract a new kind of investor to the stock and thus will be a positive overall.
Disney has a solid balance sheet with $8.47 billion in cash and short-term investments. The company does have fairly high debt of $48.4 billion, but the vast majority is long-term debt and, therefore, manageable.
Valuation and forecasts
In order to value Disney, I have plugged its latest financial data into my discounted cash flow valuation model. I have forecast 9% revenue growth for next year, or the next four quarters in my model, which is in line with analysts' forecasts. This is a little optimistic given the company grew its revenue by around 8% year over year in the first quarter. However, a 9% level would be similar to what was achieved in fourth-quater 2022, thus this is not unbelievable. In years two to five, I have forecast a faster 15% growth rate per year. I expect this to be driven by a rebound in the cyclical economy, which will likely boost park attendance. In addition, I expect continued growth in Disney+ and the various other streaming channels.
Moving onto margins, I have forecast a pre-tax operating margin of roughly 17% over the next eight years. I expect this to be driven by the $5.5 billion in cost savings targeted and management has also forecast Disney+ to be profitable by fiscal 2024. Either way, a 17% operating margin would just be a return to the level reported in 2019. Disney also generated an operating margin of between 21% and 26% between 2013 and 2018, therefore this is still fairly conservative, especially since that was before Disney+.
Given these factors, I get an intrinsic value of $117.89 per share and thus the stock is about 16% undervalued at the time of writing, according to my valuation and forecasts.
The company also trades at a non-GAAP forward price-earnings ratio of 24, which is 42% cheaper than its five-year average.
Risks
The recessionary environment may be a risk for Disney given its parks and cruises fall under the discretionary spending category. With high inflation and rising interest rates, consumers may cut back on these extra luxuries. Global uncertainty and political power moves by countries such as China are also not great for Disney's Shanghai park, which may get caught in the crossfire, though this is unlikely.
Iger is also a big personality and has recently ruffled the feathers of Florida Governor Ron DeSantis regarding a controversial bill. This has resulted in a temporary removal of Disney's rights over the Reedy Creek area around its park. I personally believe Iger should stay out of politics from a vocal standpoint for the benefit of other shareholders, though I do respect him standing up for what he thinks is right.
Final thoughts
Disney is a brand powerhouse that has a number of competitive advantages. I believe the return of Iger as CEO is a positive and his bold cost-cutting moves are welcomed. The company has a more diverse business than ever, but I do expect it to face challenges over the next 12 months as consumers are impacted by the macroeconomic environment and cost initiatives are executed. Overall, given my valuation model and forecasts indicate the stock is undervalued intrinsically, I will deem Disney to be a "fairy tale" investment for the long term.
