Disney is one of the most recognized brands in the world. An investment in Disney offers exposure to various sectors, including streaming, linear TV, movie studios, theme parks, hotels, and cruise lines. And there will probably be more to come. Many of the industries in which Disney operates have struggled during the pandemic. Therefore, the question arises: Is now the right time to buy Disney?
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do not own any shares in Disney. If you would like to know what is in my portfolio or if you want to make a copy of it, you can find instructions on how to do so here. I am a huge fan of the company, and I practically learned to read by reading Disney comics. I'm also a big fan of some of their franchises, such as Star Wars, and I use Disney+. However, my experiences with the company will not influence the analysis, as I will maintain objectivity. If you want to purchase shares or fractional shares in Disney, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
The Business
Disney was founded in 1923 and is an American multinational entertainment and media conglomerate. They have operations in various sectors, including streaming, TV stations, movie studios, theme parks, hotels, and cruises. Disney has three business segments: Entertainment, Sports, and Experiences. The Entertainment segment encompasses the company's non-sports-focused global film, television, and direct-to-consumer (DTC) video streaming content production and distribution activities. It is the largest segment, contributing approximately 45% of the revenue. The Sports segment includes the company's sports-focused global television and DTC video streaming content production and distribution activities, primarily through ESPN. The Sports segment is the smallest, contributing approximately 19% of the revenue. The Experiences segment includes the company's theme parks, resorts, cruise lines, and consumer products, and contributes approximately 36% of the revenue. Disney is renowned worldwide for its characters, such as Mickey Mouse and Donald Duck, and its movie franchises. They own the two most profitable franchises in Marvel and Star Wars. I believe that most people are familiar with Disney, so I won't provide a lengthy description of the company. As most people around the world know, Disney, it is obvious that Disney has a huge brand moat.
Management
Their CEO is Bob Iger. He returned as CEO in November 2022 for a four-year term. He previously served as CEO from 2005 to 2020. He first joined Disney in 1996 and held several positions before being named CEO. During his initial term at Disney, he was acknowledged as one of the best CEOs the company has ever had. He was responsible for acquiring Pixar (2006), Marvel (2009), Lucasfilm (2012), and 21st Century Fox (2019). He was also responsible for launching Disney+ and for opening Disney's first theme park and resort in mainland China. Bob Iger's initial term as CEO was also beneficial for investors, with the stock experiencing an annualized gain of 12,3%. As a leader, he believes in clear and straightforward communication, and he prefers to focus on no more than three strategies. During his first term, he concentrated on producing the highest quality creative content, promoting innovation, leveraging the latest technology, and entering new markets. We haven't heard much about his strategy for his new tenure as CEO, but he has mentioned that he intends to uphold the hiring freeze implemented by the former CEO. Additionally, he wants to introduce a new organizational structure that empowers Disney's creative teams to make decisions. Lastly, he wants to focus on making the streaming business profitable. During his initial term as CEO, Disney was acknowledged as one of the most reputable companies in America and the world by Forbes (2006-2019). It was recognized as one of the world's most admired companies by Fortune magazine (2009-2021) and as one of the world's most respected companies by Barron's (2009-2017). He has also been named CEO of the year several times. I believe that Bob Iger's credentials demonstrate that he is the ideal person for Disney, and I am very confident in his role as CEO.
The Numbers
The first metric we will examine is the return on invested capital, also known as ROIC. We require a 10-year history, with all figures exceeding 10% for each year. While Disney has demonstrated strong performance in the past, it is evident that the company has suffered during the pandemic and has not been able to achieve the same high numbers as before. The financial performance from fiscal year 2020 and beyond has been unacceptable, and I will need to see significantly improved numbers before considering investing in the company. Hopefully, we will not experience another pandemic anytime soon, but I will need to see Disney getting back on track before investing in the company.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most crucial of the four growth rates I used in my analyses, which is why I will continue to utilize it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The figures are a bit mixed, but Disney has managed to increase its numbers year over year in most years, which is reassuring. The significant increase in 2019 was due to the $71.300.000.000 acquisition of 21st Century Fox, which boosted the equity for that year.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. The free cash flow appeared strong until the acquisition of 21st Century Fox in 2019. Since then, the free cash flow has remained positive but has decreased significantly, as has the leveraged free cash flow margin. However, we have seen a slight rebound in 2023, which could indicate that Disney will manage to deliver higher numbers in the future. This is also something that management believes, as they have stated that they expect free cash flow to significantly improve in fiscal 2024, approaching pre-pandemic levels.
Debt
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a 3-year period. We do this by dividing the total long-term debt by earnings. After conducting the calculations on Disney, it appears that the company has a significant debt that could be paid off in 17,88 years. The high debt is a result of acquisitions. Especially the acquisition of 21st Century Fox, which is Disney's largest acquisition to date. I personally don't like to invest in companies with such high debt, and I would prefer to see management focused on debt reduction.
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Risks
As with all other companies, there are some risks you need to consider if you are going to invest in Disney. Macroeconomic factors. Declines in economic conditions, such as recession, economic downturn, and inflation, can affect Disney as consumers will have less discretionary spending. In the past, economic downturns have led to reduced guest spending at Disney's parks and resorts, lower purchases of advertising and prices for advertising on their broadcast and cable networks and owned stations, decreased performance of its home entertainment releases, and lower purchases of company-branded consumer products. Management believes that similar impacts can be expected if such conditions recur. Furthermore, Disney has stated that the recent inflationary conditions have increased some of their costs, which is affecting profitability.
High debt. In his book "Rule #1 Investing," Phil Town mentions the following about debt: "A business that carries a significant amount of debt compared to its income faces an uncertain financial future." "If there are any economic problems, a business with a substantial amount of loans could be in serious trouble." Disney has accrued significant debt, partly due to their acquisition of 21st Century Fox and also as a result of the pandemic. I don't think a company like Disney will go bankrupt, but its inability to take on more debt could hinder future growth. Thus, I would like to see management prioritize paying off debt.
Competition. Disney has high expectations for its Entertainment segment in the future, but the streaming industry is fiercely competitive. Warren Buffett has remarked that "the streaming business is tough". Warren Buffett's reasoning is that people have only 24 hours in a day and two eyes, making it difficult to increase demand. Furthermore, Disney competes with companies such as HBO, Amazon Prime, and Netflix. The lack of a competitive advantage in the streaming business makes it very easy for consumers to switch from one company to another if a streaming service does not provide the content they like.
Reasons to invest
There are not only risks, but also a lot of potential for Disney in the future. Their streaming business is expected to become profitable. Currently, Disney+ is not profitable, but management anticipates it will become profitable by fiscal 2024. Furthermore, Disney has acquired the remaining stake in Hulu from Comcast. According to management, this move will further Disney's streaming objectives. Thus, management anticipates that Hulu and Disney+ will lead to higher engagement, more advertising opportunities, reduced customer turnover, and lower customer acquisition costs, ultimately boosting Disney's overall margins. Management has also mentioned that they have additional opportunities for improvement in their streaming business that will will arise from implementing stronger standards around account sharing, but they don't expect a meaningful impact from this until 2025.
The Sports segment. The long-term outlook for sports online video streaming is high, as the market is expected to grow at a compounded annual growth rate of 24,6% until 2030. Disney is well positioned to capture a share of that growth, as management has indicated that ESPN is a highly popular and in-demand product in the United States. Furthermore, Disney has recently launched ESPN BET, indicating their foray into sports betting through an agreement with Penn Entertainment. The sports betting market is expected to grow at a compound annual growth rate of 7,7% until 2028.
The continued success of the Experiences segment. The Experiences segment has shown strong performance numbers after the pandemic. Compared to pre-pandemic levels in fiscal 2019, revenue has grown by over 25% and operating income by over 30%. Furthermore, over the last five years, the return on invested capital has nearly doubled in their U.S. parks, while the operating margins for the segment have increased by almost 300 basis points during the same period. Management believes it has an opportunity to expand Disney Experiences into a larger and more successful cash flow-generating business, and that the segment will continue to be a powerful growth engine. Thus, they plan to make substantial investments in the segment over the next ten years to "turbocharge" growth.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 1,29, which is from the fiscal year 2023. I have selected a projected future EPS growth rate of 13%. Finbox expects EPS to grow by 12,6%. Additionally, I have selected a projected future P/E ratio of 30, which is twice the growth rate. This decision is based on Disney's historically higher price-to-earnings (P/E) ratio. Our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $28,14. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Disney at a price of $14,07(or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 7.588, and capital expenditures were 4.743. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a general guideline, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 3.320 in our calculations. The tax provision was 1.379. We have 1.830 outstanding shares. Hence, the calculation will be as follows: (7.588 – 3.320 + 1.379) / 1.830 x 10 = $30,86 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Disney's free cash flow per share at $2,68 and a growth rate of 13%, if you want to recoup your investment in 8 years, the Payback Time price is $38,63.
Conclusion
I believe that Disney is an intriguing company due to its strong brand moat. I also appreciate Bob Iger's return as CEO, considering the remarkable job he did for the company previously. Disney may encounter short-term challenges if a prolonged recession restricts people's discretionary spending. I am concerned about Disney's high level of debt, and I believe that management should prioritize debt repayment over restoring the dividend, as they have recently done. Competition will also pose a risk in the streaming industry, and although Disney may make its streaming business profitable by fiscal 2024, I believe it is the least attractive business for Disney. Disney should be able to capitalize on the expansion of live sports streaming, but it is also contending with competition in this realm as major tech companies have ventured into the live sports industry. I am particularly fond of Disney's Experiences segment, and it would be the reason for me to invest in Disney. However, at the present moment, I believe the risks outweigh the potential, and I will not be investing in Disney at this time.
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