The Walt Disney Co. (DIS, Financial) just got downgraded by KeyBanc. As a result, many investors may be wondering if the downgrade was justified and what it means for the future of the stock.
At first glance, the reasons for the downgrade seem to be valid. This, however, is not by itself negative news. Disney appears to be significantly undervalued, the fundamentals are not bad and the argument presented by one analyst that buying the dip has been a losing trade is highly questionable.
Why the stock was downgraded
Brandon Nispel, an analyst at KeyBanc Capital Markets, downgraded the stock to Sector Weight from Overweight on Thursday, saying in a note to clients there is "meaningful uncertainty" as the "2024 financial setup feels a lot like 2023."
Among the reasons for the downgrade were stalling direct-to-consumer subscriber growth, a failure to differentiate DTC churn, sagging Disney content sales, a "materially harder" reality for moving ESPN to streaming and fears that domestic park expectations appear too high in the U.S.
Nispel wrote, "We prefer to step aside, acknowledging meaningful uncertainty, and wait for further catalysts, as buying the dip has been a losing trade." Further, he sees "more negative than positive [near-term] catalysts.”
Market reaction to the downgrade
Do I agree with all these reasons? I would say they have a high degree of validity, but investors should not panic. When a stock gets upgraded or downgraded, the marked could either move the stock a lot or just brush off the news. On June 29, Disney opened at $87.80, about 1.78% lower than its closing price of $89.39 on June 28. However, it closed at $88.95 on Thursday, a gain of 0.14%.
The total elimination of losses may not mean much as it was just one day of trading, but, on the other hand, the stock did not tank on the news.
Value
A look at Disney's valutaion metrics suggest it is significantly undervalued, which may be a good reason to shrug off the downgrade news.
The stock trades with a price-book ratio of 1.62, which GuruFocus says is close to a 10-year low of 1.6. Similarly, the price-earnings ratio of 39.48 is close to a three-year low of 39.16 and the price-sales ratio of 1.87 is close to a 10-year low of 1.85. This confirms there is plenty of hidden value for the shares.
Additionally, Disney has as GF Value of $160.54, which indicates potential upside of around 80% from the latest closing price.
The GF Score of 80 out of 100, however, implies it will likely have average performance going forward.
Warning signs and positive trends
There is some cause for concern as GuruFocus has also pointed out Disney's declining margins. The company's gross margin has been in long-term decline, falling at an average rate of 6.8% per year. At the same time, the operating margin has been in a five-year decline. The average rate of decline per year is 27.5%.
On a more positive note, the company recorded an annualized return on equity of 5.24% for the quarter that ended March 31. This ROE is ranked better than 54.69% of the 960 companies operating in the diversified media industry. It has also rebounded from a low of 0.69% in September 2022, stabilizing above 5% for the past two quarters.
Why the buying the dip has been a losing trade argument is questionable
One of the arguments Nispel made was that buying the dip on Disney was a losing trade. While it may have some merit, I do not think it is 100% accurate.
It is true Disney's shares have underperformed in 2023 as they have only gained around 2%, while the S&P 500 has risen about 15%. A closer look at the year-to-date chart, however, shows there have been quite a few times when buying the dip proved to be a winning strategy.
For instance, on Jan. 30, the stock dipped to $107 and moved to $113 by Feb. 2. Then, on March 13, shares dipped to $92 before rallying to $101 by April 13. Again on April 26, the price dipped to $96 and moved higher to $103 by May 8. Finally, the dip to $88 on May 30 presented a nice opportunity as there was another short-term rally with the stock moving to $94 by June 13..
All these short-term moves show there have been plenty of opportunities to buy the dip, which then delivered short-term gains.
In other words, when focusing on a buy-and-hold strategy, the analyst is correct in saying buying the dip does not work. For a short-term strategy, however, the concept has worked well on several occasions.
Conclusion
In conclusion, Disney's stock may have just received a downgrade, but it remains significantly undervalued. As such, it may be an attractive opportunity to monitor throughout 2023.
