Walt Disney Co (NYSE:DIS) shares are trading at a post-election low and have lost more than 16% of their value just since early May. Given that the company owns some of the best-known brands in the world, and DIS stock both trades at just 15x FY18 (ending September) EPS estimates and offers a dividend yield of 1.6%, long-term investors might draw one conclusion: Buy Disney.
I don’t think that’s the right conclusion, however. Yes, DIS stock is cheap — but it’s cheap for good reasons. And while the narrative surrounding Disney mostly has focused on its ESPN unit’s exposure to cord-cutting, there are other reasons for worry here as well. Roughly two-thirds of the company’s FY17 operating profit is under pressure of some kind. That in turn suggests that the recent growth in Disney earnings, and the Disney stock dividend, is coming to an end. And that is bad news for DIS stock — even at 11-month low levels.
DIS Stock and ESPN
The concerns about ESPN’s impact on DIS stock are well-known. The ‘cord-cutting’ trend fueled by streaming services such as Netflix, Inc. (NASDAQ:NFLX) is only accelerating. ESPN’s business model was based in large part on charging exorbitant fees — now $9 per customer per month — to cable companies whether the subscriber watched sports or not. But those subscribers are eroding, including a 3.5% decline in Q3 across the entire ESPN portfolio, per Disney’s 10-Q. Meanwhile, management said on the Q3 conference call that ad revenue for ESPN itself is down year-to-date.
All of this reduced ESPN profits, according to DIS stock filings and commentary, and the Media Networks segment as a whole saw operating income decline 5% through the first three quarters. Disney is planning to roll out its own ESPN direct streaming service but that may not be enough.
Contracted affiliate fee increases — many from deals executed earlier this decade, in a different media environment — from operators like Comcast Corporation (NASDAQ:CMCSA) and Charter Communications, Inc. (NASDAQ:CHTR) are offsetting the impact of subscriber losses on affiliate fee revenue. (That revenue actually has risen 3% so far this year, across the entire Disney portfolio, which includes Freeform, the Disney Channel, and other properties.) That will change. At the same time, contracted rights fee increases for the NBA and other sports will steadily increase costs over the next few years.
These concerns are known, admittedly. InvestorPlace columnist Lawrence Meyers even argued in July that, as a result, Disney should spin off or sell the ESPN unit. But ESPN isn’t the only problem here.
Concerns Beyond ESPN
The Media Networks group as a whole — which includes the cable properties and ABC — has generated a whopping 45% of operating profit YTD. And within that group, ESPN isn’t the only problem. Disney Channel and Freeform both lost subscribers in FY16 (FY17 data hasn’t been released yet). The pressures there are the same as at ESPN. The reason the sports network gets so much attention relative to DIS stock, and the stability of the Disney stock dividend, is that it is the largest business in the company’s largest segment. So, 45% of profit is from a business likely in decline and that’s a major problem.What about the news in the other 55% of earnings? Not that great. The Parks & Resorts business is growing nicely. Shanghai Disney has been a clear winner. That’s about a quarter of profit. The other 30% comes from Studio Entertainment and Consumer Products & Interactive Media. Profit in both segments has declined year-over-year.