Walt Disney stock: fairy tales at all costs?

After several years of moving sideways, the Walt Disney stock skyrocketed in 2019, gaining over 30 percent in value within 12 months. The Corona pandemic has quickly brought this upward trend to a stop. It quickly became clear that Walt Disney will not remain unaffected by the pandemic. Theme parks in particular have been hit hard and even had to close down at the beginning of the pandemic. As a result, the euphoria for the Walt Disney stock quickly evaporated and the price almost halved for a short time. Fortunately, the last few weeks have brought some relief to shareholders. The Walt Disney stock has benefited greatly from the recent rally and has recovered a good portion of its losses. Right now, the price is only 20% below the high of the year. Those who entered the market at the bottom should be particularly pleased. They are already sitting on a price gain of almost 50% (!).

Click here to switch between logarithmic and linear chart

Many are now wondering whether the price recovery is justified and whether it is still worth buying Walt Disney stock. You will find the answer to this question in this analysis.

Walt Disney Stock
Logo
Country	USA
Industry	Entertainment
Isin	US2546871060
Market cap.	225 billion USD
Dividend yield	1.4%
Dividend stability	0.92 (max. 1.0)
Earnings stability	0.89 (max. 1.0)

The business model: How Walt Disney earns money

The Walt Disney Company is a highly diversified US media company in the entertainment and media industry. In addition to film productions, TV networks, streaming services, books, video games and theme parks also play an important role. The latter are popular destinations in the USA, France, China and Japan.

Assets of Walt Disney (Source: Company presentation from 2019)

Walt Disney categorizes its activities into four different business segments. Walt Disney earns about three quarters of its total revenue with the two largest business segments “Parks, Experiences & Products” and “Media Networks”:

Revenues per segment of Walt Disney (Source: FactSet Workstation)

The first segment includes theme parks and the cruise line Walt Disney Cruise Line. In this segment, Walt Disney generates sales through admissions and hotel stays, as well as the sale of food and beverages in the parks. The Revenue from the cruises also adds to that.

The Media Networks segment includes TV stations such as Disney, ABC, National Geographic and ESPN. This segment primarily generates income from affiliate fees, advertising and license fees.

The remaining quarter of sales is generated by the Studio Entertainment and Direct-to-Consumer & International segments. Studio Entertainment relates to the production and distribution of movies. This category includes the subsidiaries Walt Disney Pictures, Twentieth Century Fox, Marvel, Pixar and Lucasfilm.

The Direct-to-Consumer & International category includes the international versions of the TV channels and the streaming services share, Hulu and ESPN+. This segment impresses with strong growth rates, but still operates at a loss:

Profits per segment of Walt Disney (Source: FactSet workstation)

Entering the streaming industry with Disney+ and Hulu

In November 2019 Disney launched its new streaming service Disney+. The service was immediately well received and showed impressive growth rates. Disney+ now has 54.5 million subscribers (as of 4 May 2020).

Walt Disney also holds 67 percent of another streaming platform called Hulu. The remaining 33 percent are still owned by Comcast. However, Comcast has agreed to sell its stake to Walt Disney at a later date. Walt Disney also owns the streaming service ESPN+, which is significantly smaller than the other platforms.

This makes Walt Disney a serious player in the streaming industry. Even if the competitor Netflix is still clearly ahead in terms of subscribers, as the following chart shows.

Netflix vs Walt Disney streaming subscribers (Source: CNBC.com)

However, the extremely positive acceptance of Disney+ by customers and the rapid expansion show that Walt Disney definitely has potential to participate in this industry.

A major competitive advantage of Walt Disney is its ownership of valuable brands and film studios. These include the productions from Walt Disney, Marvel Studios, Pixar and Star Wars. The productions from these studios and the associated media franchises are so valuable because they have a loyal fan base. If Walt Disney offers this content exclusively on its own platforms, the company can attract customers from other streaming services to its own platforms.

How profitable is Walt Disney?

These intangible assets greatly contributed to the success of Walt Disney. This is also reflected in the development of profits. In recent years, Walt Disney has been able to continuously increase earnings and cash flow per share. A part of this was also due to stock buybacks. However, unlike some other companies, these were not exclusively financed by issuing debt, but paid in part by the free cash flow.

Development of profits and cash flows of Walt Disney

Effects of the Corona pandemic

In the chart, you can see a very negative development in profit and cash flow for the 2020 forecast. This is because of the corona pandemic, which is a problem for Walt Disney. The theme parks had to close, and cruises had to be suspended. As a result, all sales from these segments were suddenly lost, while parts of the costs continued to accumulate. If sales fall more sharply than costs, the profit margin also falls. You can see this in the following graphic from the drop in the operating margin.

Development of revenues and operating margin of Walt Disney

Walt Disney is more affected by the Corona pandemic than many other companies. Nevertheless, there is cause for optimism. For example, streaming services are benefiting from the fact that people are spending a large part of their time at home. Some of the new customers are likely to keep their subscriptions even after the pandemic, which favors the growth rate of streaming services. Especially in the young phase in which Disney+ is still in, a rapid increase in user numbers is essential to position itself on the market.

Another positive sign is that Walt Disney should recover quickly after the crisis. The business model is still intact. So, the company just has to ride out the slump. This is easier said than done for a lot of companies, but Walt Disney has good access to the capital markets and has already secured financing to strengthen its cash position. In addition, the dividend for the first half of the year has been suspended. As a result, Walt Disney has built up a decent cash cushion to survive the crisis.

Are Walt Disney’s dividends safe?

Just a few months ago, I would have answered this question with a confident “yes”. Unfortunately, the Corona pandemic has put a question mark on many things that were considered safe until recently. Now, you might think that a suspension of the dividend means that it is not safe. However, I would make a distinction. It is correct that Walt Disney’s business model is feeling the negative effects of the crisis. This is simply because a large part of the sales and profits are in the amusement park and cruise line segment. They are not exactly known for their low admission prices. So, Walt Disney is dependent on its customers having enough disposable income for entertainment purposes. In a bad economic situation, demand can certainly collapse.

This business segment is almost helplessly exposed to a pandemic. Thank goodness the occurrence of a pandemic is a rather rare event, which hopefully will not happen again for a long time. That’s why I continue to see Walt Disney as a solid dividend stock that will once again spoil its shareholders with rising dividends once the Corona crisis is over. Walt Disney will also generate stable and high cash flows again as in the years before. You can see that in the chart by the amortization power. It shows how much of the free cash flow remains after the dividend payment.

Amortization power of Walt Disney

Walt Disney has always easily covered the dividends with free cash flow, and I expect Walt Disney to return to this situation in the coming years. The resumption of dividend payments is only a question of time for me.

I would even describe the dividend of Walt Disney as safe, despite the suspension of payment. In my opinion, dividends are only uncertain if they are not covered by the company’s profits and cash flows in the long term. This affects companies that pay a dividend that is too high and is not supported by their business model. This is not sustainable in the long run. However, this is not true for Walt Disney. In normal times, the dividend is easily covered by the profits. In my opinion, the argument that a dividend must be secure even in times of crisis does not apply to this special situation. For example, Walt Disney continued to pay dividends during the financial crisis in 2008/09. Walt Disney’s business model is crisis-proof in terms of a “normal” recession.

Is Walt Disney’s stock undervalued?

The price of the Walt Disney stock has recovered significantly from its low point. Currently the price is 125 USD. The fair values determined by the Dynamic Fair Value Calcluation are significantly below this price. Especially the expected deterioration of the result in the current business year is dragging the values down. At the low point in 2020, the fair values are between 9 USD and 50 USD, depending on the valuation metric. This implies a big overvaluation. However, the 2020 financial year is not meaningful for the valuation, as earnings and cash flows will recover in the coming years. Nevertheless, you can see that even in 2021 a full recovery is not expected. The fair values for 2021 are still far below the current price of the stock.

Fair value estimates of Walt Disney stock

For this reason, I think the stock is too expensive. In my opinion, the sharp rise in the share price in recent weeks is not justified. The price is almost at pre-crisis levels, although the business is still negatively affected. I am critical of the argument that the stock is undervalued because it is trading below the price before the Corona crisis. If you look at the dynamic valuation, you can see that the Walt Disney stock was very pricey, if not overvalued, at its peak. I would regard the current price as justified if Walt Disney did not experience negative effects from the pandemic. But that is not the case. To pay a high price today for a company that will probably not return to pre-crisis levels for another year or two seems too risky to me.

Conclusion: Walt Disney’s stock is too expensive right now

Despite the undisputed quality of the company, I think the Walt Disney stock is currently too expensive. Although I believe in the long-term success of the company, the market seems to be too euphoric and to value the stock too generously in my eyes. In this analysis, I have argued that the Corona pandemic is an isolated event and that Walt Disney has been hit hard but will recover from it. The expansion of streaming services – especially Disney+ – is promising. Despite these positive aspects, the negative effects of the pandemic should not be completely ignored when it comes to the fair value of the stock. Even if sales and profits do recover, they will initially fall sharply, resulting in a discount to the price. In my opinion, however, this discount is not high enough at the moment.

To answer the question of whether the train has already left the station after the price recovery: I think it has. I would only consider buying if the stock price corrects significantly again.