It has been a very quiet few years for Walt Disney’s (NYSE: DIS) share price. In fact, Disney shares were changing hands for somewhere between $110 and $115 each at this point back in 2015. Right now they are going for around $106.25. Chuck in roughly $4.50 per share paid out as cash dividends in the intervening period, and we come out roughly where we started. Actually it is slightly worse than that because we have three years worth of inflation to factor in too. In contrast, the Dow Jones Industrial Average – of which Disney is a constituent – has put on nearly 50% over the same period assuming reinvested dividends.
So what’s up with Disney stock? My guess is two things are at work here. Firstly, we have the inevitable hangover from the good times between 2010 and 2015. In this period Disney’s business and stock looked unstoppable. The former grew from making $2.05 per share for its stockholders in 2010, to $4.90 in 2015. The latter basically trebled in the space of four-and-a-half years (plus an additional four bucks per share in cumulative dividend payments).
The kicker is that these two performances don’t entirely match. I mean the business basically doubles its earnings power yet shareholder returns treble. Unless you’re dealing with a stock that is ludicrously undervalued, then at some point shareholders will always have to pay the piper for that kind of positive discrepancy. This is where the hangover kicks in.
The second point I’d make regards Disney’s Media Networks segment. This is responsible for around 45% of total company operating profit and includes sports broadcaster ESPN as well as ABC. Last year, Media Networks made $6.9 billion in operating income. Back in 2015 it made $7.8 billion. The issues surrounding subscriber losses and lower advertising revenue are well documented. Indeed I’ve written about ESPN before so I won’t rehash the cord cutting issue too much. On top of that stand the content costs demanded by the respective leagues (NFL, NBA, etc). These continue to grow.
That said, the segment is still an absolute cash cow for Disney with a near 30% operating margin. In addition, the other parts of Disney’s business – the parks, the resorts, the movie studios pumping out Star Wars and Avengers titles, the consumer products that line Disney stores, and so on – have done pretty good. In 2015 they made $6.9 billion in combined operating income for Disney. Last year they made $7.9 billion.
The Bigger Picture
You’ll notice I deliberately set out Disney’s business in two parts, which is something I’ve done before. The reason for that is because, in terms of threats, you’ve probably read a whole lot of articles covering Netflix and streaming. The theory goes that if folks stop subscribing to cable television, then companies like Disney earn less in affiliate fees – i.e. the cash that cable companies pay per month per subscriber – and less in advertising revenue (fewer eyeballs equals lower advertising dollars). As you can see from above, this looks like it has already had an impact on the Media Networks division.
That said, there’s a good case to claim that these supposed threats to Disney’s business are overblown. To illustrate why let’s take fiscal year 2014 as a baseline. I’ve chosen that year because ESPN was still riding high with 96 million subscribers. In 2014 Disney made roughly $7.5 billion in total after-tax profit. Despite the trouble that traditional television has had, analysts forecast that Disney will earn somewhere around $10.75 billion this year; 45% higher than four years ago.
The per share numbers are actually even better because of the cumulative effect of share repurchases. On that basis Disney will have grown its income by 65% in that time. So the bigger picture doesn’t look too bad. It’s just that the hangover period has seen the valuation slashed from nearly 25x earnings to 15x earnings. What is the net result? Profit has actually grown, but the stock goes nowhere.
Now, even if you were so pessimistic on the future of television that you discounted Media Networks to zero, you can buy Disney shares today for 30x the net earnings of the other segments. That’s the 50% of Disney’s operating profit that is much more resilient to long-term change. It’s an economic engine that generates something like $5 billion in after-tax profit. If it is successful in its bid to acquire the lion’s share of Fox then that will go even higher. In any case is there enough insurance in Disney’s valuation to wait out the slight Media Networks issue? Considering a total earnings yield of over 6.5% then I’m inclined to say yes.