Stock Recommendation Buy Alert Example: The Walt Disney Co.
New York Stock Exchange (NYSE) Performance Year Over Year
Do I need an introduction to this one? Disney is a worldwide entertainment company with one of the most recognized brands in the world. Its parks are a pilgrimage that almost everyone strives to make at some point in their life. Disney provides stories, movies and core memories for almost every person alive, from the classics of “Pocahontas” to the new movie “Elemental” (currently my daughter’s favorite). They are also the owners/majority owners of known entertainment brands such as ESPN, HULU, and ABC. They own Disney Cruise lines and sell billions of dollars in toys and other merchandise. Even with all the brand recognition and loyal customers, Disney has drastictically been underperfoming the market. Many investments get compared to the S&P 500 because an individual could invest in an S&P 500 fund with virtually zero effort. When comparing your company against the S&P 500, you’re essentially comparing it to what you would make as a default. To do this with Disney, over the past 10 years their stock performance has underperformed significantly to the S&P 500 - 201% for the S&P vs 49% for Disney as of November 2023. 49% is less than 201%, so you’re correct if you’re thinking that’s bad. This report will go over what the issues were, what Disney is doing to address them, and why the stock is a good investment at the advised purchase price.
Issues
Why has the stock suffered? The main issues that have caused the underperformance are losses from streaming and management structure. Over the past few years, streaming has exploded in growth. All the streaming companies such as Disney, Netflix and Paramount (to name a few) were spending billions of dollars creating content to have user growth. Profitability was not a concern. Some companies can use economies of scale to do this better. Netflix is the gold standard; they create content while maintaining a strong cashflow. The other companies, not as much (Disney included). If you look at Disney, the company is broken into different subcategories. Streaming is one of them. They have been growing rapidly but at the cost of not being profitable. This all caught up to them in the past few years. This, along with the massive acquisition of Century Fox for $52 billion (which greatly increased their yearly interest cost) further hurt their profitability. There have also been management style issues. They had a centralized management structure, where the C-suits would direct all decisions. This makes sense in some companies, but not Disney. Parks, such as Disney World and Disney Land, are clearly a different section of the company than streaming and/or merchandising for example. So why not let them act independently? Disney has the benefit of having cash flow from other elements of the business, such as parks. However, the profits from the other Disney elements have been used to subsidize the loss from streaming so much, that the company had to cut its dividend in 2020. To be fair, this is most likely correlated to the Covid shutdown. The dividend was recentyl reinstated but only at $0.60 a share, much less then the pre-covid amount of $1.76, but a start in the right direction. On top of that, Disney also ran into recent issues with the Governor of Florida and the Writers Guild with strikes. When it rains, it pours, right?
Strengths
With all that said, how is Disney a strong company? For all the issues laid out previously, Disney is and will continue to be at its core, a fantastic business. Let’s look at parks. Think about all the families that make the very expensive trip to one of the Disney parks. Many travel hundreds or thousands of miles, stay at a hotel for several days or more, and enjoy the many park attractions. This can quickly run up into the $1000s. But why don’t they just drive to a nearby park? Think about all the parks that the typical family will pass just to get to Disney? They could forgo travel expenses, lodging, and if the drive is close to home, skip meal expenses too. But they STILL do it! That is the brand power Disney has, which runs in sync with pricing power. If you think of other theme parks that exist (Six flags, Kings Dominion, Cedar Point, for example) which park would you bet on to withstand the test of time?
Next up, Disney Studios. Pictured below is a list of the top 20 grossing films of all time. Notice anything in particular? 13 of the 20 are Disney movies, including the top 3. Yes, I am sure that there are movies that exist that flopped. Which studio won’t have those. But in aggregate, Disney produces quality films that people just can’t help but watch repeatedly. The proof is more than evident. Many of their movie franchises also have a great business attribute where there are multiple in a set, which leads to further time spent watching them. It would be hard to watch the latest avenger movie without watching all the previous ones. It wouldn’t make sense to watch Avatar 2 without watching Avatar 1. Disney also has a strong record of buying great brands (albeit some at an expensive price) to include: Fox Family Worldwide Entertainment, Pixar, Marvel Studios, George Lucas Films, 21st Century Fox, and currently the remaining portion of Hulu from Comcast.
Disney streaming is probably the one category with the most uphill battle. It is going against a juggernaut, Netflix. The one advantage that Disney has though, is a massive collection of movies and shows that have been produced through the decades. Streaming is currently operating at a loss ($400 million loss as of Q4, 2023). They’ve been working relentlessly to bring that number in the green. For reference, in Q4 of 2022 they had a loss of $1.5 Billion for streaming. Disney streaming and the studios go hand in hand from the consumers’ point of view. So, streaming will get the benefits of Disney’s Studio and the deep catalog of movies/shows that come with it. The company is predicting that streaming will be cash flow positive by 2024. All these together create a fantastic flywheel effect for the company as a whole. In business, the flywheel effect can be described as a business making small but positive advancements constantly that steadily make the business improve overtime instead of one big action. For Disney, an example would be you spend time watching Disney+, this leads you to become a Disney fan, which makes you want to go to a Disney Park or cruise, leading you to purchase merchandise, and returning right back to where you started when you return home - watching Disney +. This is similar to an economies of scale concept. Disney parks are massive and have a lot to offer, so it attracts more people, making more money, leading to more park improvements and so on. Or for streaming, they have a large existing catalog of movies and shows, which brings viewers to their streaming platforms, creating more cash, in turn giving Disney more money to produce new movies and shows, so on.
Why Buy Now?
That sets the stage for the next question, why am I building a position in this stock now? Disney has taken notice of its faults and is taking action to right the ship. For starters, Bob Iger, Disney’s previous CEO to Bob Chapek, came back in November of 2022. Most of the issues (lack of spending control and priority on profits) were under Bob Chapek. That’s not to say Bob Iger didn’t have any issues during his tenure, but it is a positive Bob Chapek is gone. In Bob Chapek’s defense, he did take the helm of Disney right before Covid and theme parks were crushed at that time. With the return of Bob Iger, he’s laid out a specific plan addressing all known issues and appears to be making headway on all of them. He is restructuring Disney into 3 segments (still under one company); Experiences, Entertainment, and Sports. Each unit will have its financials broken out individually. This will help hold EACH unit responsible for its own profits, rather than subsidizing others. This will also let each unit make meaningful decisions on its own, rather than a centralized bureaucracy that will slow the business. Notice that Sports is its own category now. ESPN has been almost an afterthought previously, but now its shifting to a main priority. Disney is also making headway to get into sports gambling which is hugely profitable. Think about it; Where do you watch sports in the U.S.? If ESPN has its own gambling arm and controls the advertising displayed while you watch, which sports betting company would you probably go through? ESPN is Disney’s most profitable unit by far in respect to percentage with a Q4 2024 revenue of about $4 Billion and Operating income of $1 Billion.
With Bob Iger, profitability is a priority and it’s showing. In Q4 of 2023 alone, he cut costs by $7.5 billion (yes BILLION) after estimating $5 billion in cuts. They’ve done this with a combination of price raises (for example, the Disney + Premium increased 27%) and cutting jobs (approx. 8,000) where appropriate. Disney is expecting streaming to finally be profitable by the end of 2024. Bob Iger is pushing hard to concentrate on quality over quantity. Less movies but more time invested into each. The graph below was taken directly from the Q4 2023 presentation showing what they are prioritizing.
There are external factors to consider on the turnaround for Disney as well. The writer’s strike is coming to an end. You might have noticed that a lot of release dates for your shows/movies had been delayed, this was the reason. Several activist investors, one being Nelson Peltz, have accumulated a huge position in Disney. As of Nov 2023, Nelson Peltz had about $2.6 Billion. Why does this matter? When a good activist (Nelson Peltz has a fantastic record of getting involved in companies and helping with a turnaround) gets involved, it can cause the business to improve and thus the stock price to increase. Without getting too much into the weeds, because of the activists’ massive position in the company they can usually pressure the CEO and boards on decisions with the intent to have the stock price go up. It’s always nice to have a billionaire in the stockholder’s corner, which is us! On top of that, from the timing of his purchases (Q4 2022- now) the range he was purchasing was on avarege higher then todays price, which means we can be buying in at a lower price which should increase our returns on the investment.
All this boils down to what Disney is doing to improve cashflows. Below is a graph showing that they are getting closer to historical levels. When that happens, the dividend will more than likely be increased and the company will have much more funds for growth in all major categories.
Valuation + Conclusion
Putting an estimated value on any stock for the future is ALWAYS AN ESTIMATE. You could put 100 of the top analysts and fund managers in a room and ask, “What will the price of a stock be in a year?”, and you will get 100 different answers. All methods and models derive value based on estimation of something, whether it be sales, earnings, free cash flow, growth, etc. That being said, we can put a broad range on the valuation using good judgement and being conservative. Sometimes it can be more art than science. That is the benefit of when we buy stocks on sale, it leaves us a wide margin for success later. A common saying amongst house flippers is “You make your money when you buy” (be ready for many real estate metaphors in the future. I spent a lot of time in my 20s in the real estate industry). The theme is that if you are buying an investment at a good enough price, it can protect you when you sell because it leaves you with enough spread and profit. Disney is a tough company to put value on the business due to its many different lines of business. I do think the most appropriate model would be price to sales. Bear with me here. The average price to sales for the last 5 years was 3 (3 in this instance is a multiple that we’ll use in a second). The average growth of sales has been 6%. So, if we have 2023 sales of $89B, then 2024 estimated would be $94.34B. Multiply the sales revenue of $94.34B by our multiple of 3 and you are at $283.02B. That would be the “value” of the business, or the market cap. To figure the price per share, we just divide our $283.02B by shares outstanding (all the shares available on the stock market), which in 2023 was 1.83B. So, $283.02B divided by 1.83B gives us $154.65 per share in 2024. Here’s a graphic for those that prefer a picture example.
To be frank, it’s crazy to assume the future, even on the most predictable of companies. And I’m sure there are many out there that will question why I used price-to-sales, not P/E or cap rate or price-to-ebitda or the hundreds of other value models. In the words of Warren Buffet, “It is better to be generally right rather than precisely wrong.” I am hesitant to put a number for an “exit price” because of all the variables that come in the investing world. Let’s say by summer 2024 the stock price does hit $154 per share. Does that mean sell? The long answer is “it depends”. The company could be a completely different company at that point and might have much more potential. Don’t worry though, I’ll put out more articles in the future when it comes that time to reassess Disney, specifically on whether to hold or sell.
It is important to remember that we are trying to predict if the company will improve in the future, or at least continue as before, regarding sales, profits, growth, etc. This requires a lot of judgement, deep thinking, and analysis, but at the end of the day we are just trying to buy a great company at a relatively low price. Buying something for less than what it’s worth is a key foundation of investing. Do I believe Disney will go to $0 in the future? No. Do I believe that the issues they currently face are solvable? Yes. Do I believe that in the future the company will be stronger and continue to produce great products in all aspects of media for everyone to enjoy? Very much so.
I have been actively building a positon in Disney. Massive companies like Disney take time to turn around and improve. I do believe that purchasing this stock under $95 is a strong investment. If you can get it even lower, all the better.
Keep in mind…
At any given time, these reports will be recommending stock holdings of about 10 different stocks. So, for them to be equally weighed, 10% of your available funds per stock would be appropriate if you purchased all the recommendations. For example, if you have $10,000 set aside to invest, $1,000 would be the position size. This is not a set rule, more of a guideline. If you like one stock more than the other, feel free to add more to that position than 10%. This is your personal portfolio and maybe you pass up on a specific stock for personal reasons. Know, that after you buy a stock, there is always the possibility that it will GO DOWN. Your first instinct may be regret or want to sell. DON’T, patience is key. This is part of the process. If anything, you should see this as an opportunity to buy more stock at a cheaper price. What many investors (me included) do is “tranche” into a stock position. This is when you buy your full position in portions. For example, if you decided to purchase $1,000 of stock ABC, you could break it up into 2 purchases of $500. You could buy $500, then wait a few days to buy $500 more. This will give you the average purchase price of the aggregate and can help with some of the pressure in trying to get into a stock at the best possible price.
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