Its been a tough run for Walt Disney Co (NYSE:DIS) shareholders. While the S&P 500 has gained 10% so far this year, DIS stock is down 2% year to date.
And the struggles aren’t exclusive to this year. Over the past 3 years, DIS stock has underperformed the market. The S&P 500 is up 23% over the past 3 years.
DIS stock? It’s up only 13% in that time frame.
What gives?
Well, a majority of Disney’s operating business is doing well. But the whole Media segment has been a drag. As consumers cut the chord and increasingly migrate to over-the-top options like Netflix, Inc. (NASDAQ:NFLX), Disney loses because fewer people are watching its media channels like ABC, ESPN and Disney Channel.
Unfortunately, the Media segment is the company’s biggest profit driver.
But big changes are coming to Disney’s Media segment. And those changes could mean this era of the sideways moving DIS stock is over.
Here’s why.
The Rest of Disney Is Doing Really, Really Well
First, it’s worth noting that a majority of Disney’s business is doing pretty well.
The company’s Parks business, which represented 31% of Disney’s revenues and 21% of its operating profits last year, has been doing well. People continue to travel to Disney’s suite of amusement parks. New additions such as Star Wars Land and Pandora ensure that park attendance will continue to grow into the foreseeable future.
Meanwhile, Disney’s Studio business, which represented 17% of Disney’s revenues and operating profits last year, has been on fire thanks to Marvel and Star Wars. It has some volatility due to movie launches, but the overall trajectory is up. In fiscal 2014, the Studio business did $7.3 billion in revenue. Through the first nine months of fiscal 2017, the Studio business has already done $7 billion in revenue, and that’s down from $7.6 billion through the first nine months of fiscal 2016.
Then there is Disney’s Consumer Products business, which represented 10% of Disney’s revenues and 12% of its operating profits last year. It has grown in-step with Disney’s Studio business. The more movies Disney releases, and the better they are, the more action figures and princess dolls Disney sells. It a simple connection that will exist into perpetuity.
So, a majority of Disney’s business (more than half of revenue and operating profit) is growing quite nicely.
Big Changes Mean Big Opportunity For DIS
But then there is the other half of Disney’s business that isn’t growing so nicely.
Disney’s Media segment has been killed by growth in over-the-top media consumption. After flat-lining last year, Disney’s Media segment operating profits have fallen 11% so far this year, including a 22% decline last quarter.
But Disney still makes some of the best and most celebrated content in the world. Just look at the Studio entertainment section. Since 2015, we are talking Star Wars: The Force Awakens, Avengers: Age of Ultron, Beauty and the Beast, Finding Dory, Zootopia, The Light Between Oceans, McFarland, USA, and many, many more.
From superhero flicks to princess fairy tales to feel-good sports stories to intense dramas, Disney makes the type of content that everyone is interested in.
This will always be the case. So all Disney needs to do to “fix” its Media problem is figure out the best way to distribute its robust content portfolio.
And that is exactly what Disney is doing. Disney is ditching its content partnership with Netflix and launching its own Netflix-like streaming services. An ESPN streaming service will launch next year. A Disney-branded streaming service will launch in 2019.
These services will see robust demand right away.
Why? Because consumers have already proven that they are willing to pay for this content. Even amid massive box office struggles, Disney is still seeing its Studio segment grow nicely.
From this standpoint, Disney is appropriately positioning itself to monetize its rich media content in today’s world of over-the-top content consumption. Wells Fargo analysts agree, and that is why they recently upgraded DIS stock to “Outperform”.
Bottom Line on DIS Stock
This shift into over-the-top content distribution will turn DIS stock around over the next several years.
The negative cord-cutting narrative will gradually turn into a positive direct-to-consumer subscriber growth story (like Netflix). The numbers will turnaround (operating profit compression will turn into operating profit growth). The valuation will rebound (DIS stock’s current 18-times trailing price-to-earnings multiple is near a 3-year-low).
Right now feels like a good time to get into DIS stock before this turnaround.
As of this writing, Luke Lango was long DIS and NFLX.
