Disney: Patience Required

by The Compound Investor

Of all the stocks covered on the site, Disney seems one of the unluckiest with respect to COVID-19. I say that for three reasons really. Firstly, nearly all of its operating segments look exposed to the impact of the pandemic. I mean, the Parks, Experiences and Products segment has obviously taken a big hit from park closures. They will only operate at reduced capacity when they reopen next month. Its Media Networks segment, dominated by ESPN, has surely taken a hit from the absence of live sports. The disruption to theatrical releases from movie theater closures has hit its Studio Entertainment segment too. You get the picture.

The second reason centers on the company’s balance sheet. Suffice to say, it is somewhat stretched following the acquisition of the lion’s share of Twenty-First Century Fox last year. The timing of that was slightly unfortunate in hindsight. In any case, the pandemic has forced the company to take drastic measures. It announced early last month that it scrapped its first-half dividend, while it has also raised billions via fresh debt issuance. Net debt stood at circa $41,000m at the end of its 2Q20, though that figure will surely head higher this quarter.

The third reason is Disney+. It is cruelly ironic that over-the-top streaming, the one area of its business you’d expect do well out of COVID-19, is loss making. That was always the plan at this early stage – the service only launched late last year – but it is still loss making nonetheless. The company reported that it had circa 54.5m Disney+ subscribers at the start of last month. The company had previously forecast anywhere between 60m and 90m by the end of its FY24.

Liquidity

As mentioned above, this was not an ideal time for Disney’s balance sheet to witness a massive external shock to the business. Gross financial debt stood at circa $55,500m at the end of its fiscal second quarter. Moreover, the company will see a significant hit to free cash flow this year given all of the disruption outlined above.

On the asset side of things, the company reported just over $14,300m in cash and cash equivalents at the end of last quarter. It raised another $900m or so in fresh long-term debt just after the quarter ended. That was followed by an $11,000m debt offering last month. Thanks to the Fed, it will pay pretty low interest rates on that. The dividend cut should also save it $1,600m in cash outflow, while the company expects capital spending to clock in around $400m lower than last year.

The above, plus undrawn credit facilities worth circa $17,000m, should see it through the crisis in one piece. The company’s cash on hand can cover the current portion of its debt, circa $12,700m of which was due in the twelve months following the end of its fiscal second quarter.

Valuation

Despite not having much positive to say, the share price has not done too badly. My screen shows the stock at circa $114.50, which is around 22% lower than it started the year at. That may not sound great, but it is around 35% higher than its lows back in March. We can probably thank the Fed again that things are not worse on that front.

On that note, it strikes me that an investment here may require a little bit of patience. My stock screener is showing FY21 profit estimates in the $6,200m region. That works out to around $3.20 on a per-share basis, which would put the stock at circa 37.5x earnings estimates. That could prove optimistic too. Just by way of comparison, that FY21 figure stood at $5.55 per share when I covered Disney back in February.

That’s the ongoing COVID-19 effect. The disruption to things like the parks and resorts – a $6,750m per annum operating profit business for Disney last year – clearly won’t disappear before its fiscal year kicks off in late-September. We also have to deal with the fact that leverage will remain elevated here for longer than previously anticipated. That means stock buybacks will remain off the table for some time to come.

Anyway, let’s assume Disney returns to making $10,000m per annum in net profit by FY22. That’s puts the stock at a very tentative 20x FY22 earnings. In the bizarro world of zero percent interest rates, I’m not actually sure that this isn’t a reasonably good deal. I also continue to add Disney shares to the Micro Portfolio as part of a regular investment program. That said, it wouldn’t surprise me if stock had a very quiet period over the next year or so. Unfortunately, it seems to have hit the perfect storm in COVID-19.

Note

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2 comments

Dividend Diplomats June 21, 2020 - 3:32 pm

Compound Investor –

If you currently own them – patience indeed. If you do not – staying on the sidelines is ideal,a s earnings may take quite some time to come back to a more normalized range.

-Lanny

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The Compound Investor June 21, 2020 - 6:07 pm

Yep, I agree.

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