Walt Disney Co (NYSE:DIS) has had a surprisingly quiet year of trading. DIS stock has fluctuated between 96 and 116, and finds itself smack in the middle of that range today.
Given all the news around Disney stock, you’d expect bigger trading swings. However, the company’s blockbuster films, ESPN struggles and merger news appear to have largely balanced themselves out.
That leaves investors with a dilemma. After a long period of consolidation, is DIS stock finally going to break out, or is it heading back below 100 again? Here are the pros and cons for DIS stock.
Disney Stock Cons
Film Division’s Declining Profitability: This isn’t to take anything away from Disney and their success with Black Panther (see below). However, massive box office smashes aren’t generating the sort of long-run income for Disney that they used to.
While DVD sales haven’t collapsed as quickly as, say, recorded music revenues, clearly DVDs are on the decline. This showed up in a big way in Disney’s studio revenues last quarter and year.
Despite that quarter containing gigantic hits such as Coco, and The Last Jedi, overall revenues fell 1%, hit by weakness in home entertainment and licensing for television. And for full-year 2017, both studio revenues and income fell by more than 10%.
While Disney continues to produce popular films, it may not generate the profit margins it once did off them due to changing consumer behavior.
Merger With Fox May Create Oversupply: Disney already produces plenty of hit movies. So its rationale for acquiring the films business from Twenty-First Century Fox, Inc. (NASDAQ:FOXA) seems a little shaky. It’s not like Disney didn’t have enough quality film IP in-house already.
And Disney is paying a high price. Fox will end up receiving about 25% of Disney’s outstanding shares in return for selling off their studio assets. Put another way, Disney is paying $66 billion, including the assumption of $13 billion in debt, to add more sports channels and film production to its already powerful place in both areas.
Given the problems at ESPN, some would say this is doubling down on a struggling division. In any case, this deal significantly weakens the argument that Disney is a diversified powerhouse, as it will rely much more on just a couple revenue streams for the majority of its profits post-deal.
Economically Sensitive Stock: DIS stock is highly exposed to the US economy. While the company is broadly diversified, almost all divisions rely on American consumer spending to remain strong.
This is now problematic for two reasons. One, the current economic expansion has continued since 2009. That’s unusually long by historic averages, a recession should be coming soon. And two, with interest rates going up, consumers will find it harder to obtain credit.
Instead of saving for trips, many families rely on home equity loans or other consumer credit to finance bigger items such as visits to Disney World. Rising interest rates will make this process less affordable.
Disney Stock Pros
Ticket Prices Going Up: Many American companies have been complaining about the lack of inflation. Since the financial crisis, consumer prices for various goods have hardly increased at all, limiting profit margins and revenue growth.
Disney is not having this problem at its amusement parks. At its lucrative Disneyland Resort in California, one-day peak tickets are going up almost 10% this year, from $124 to $135.
Regular one-day tickets are also jumping from $110 to $117. Disney announced price hikes at other parks, including its Magic Kingdom at Walt Disney World in Florida. Given that parks are Disney’s second-biggest source of revenues, price hikes are a welcome sight for DIS stock.
Cheap Stock: DIS stock is currently selling at 18x trailing earnings, making it significantly cheaper than the market as a whole. And as a beneficiary of both the tax overhaul, and substantial merger savings once the Fox deal closes, analysts see that forward PE ratio dropping to under 15x next year. Compared to the S&P 500, that’s nice indeed.
And while DIS isn’t thought of as a dividend yield play, it has some merit there as well. Disney’s starting 1.6% yield isn’t eye-catching. However, the board has increased the dividend at a 24% compounded rate over the past five years. Past increases are no guarantee of future growth at that rate.
Regardless, Disney is proving that it wants to return profits to its shareholders. DIS could become a dividend powerhouse over time.
Black Panther Is A Blockbuster: Disney’s new superhero movie, Black Panther, as an out-of-the-park success. The film generated incredible revenues over the President’s Day weekend. For that stretch, it pulled in $242 million. Only Star Wars: The Force Awakens notched a better figure historically.
Including overseas, Black Panther brought in more than $425 million in its first week, ranking it at the top of the superhero pantheon, ahead of the likes of Iron Man and Batman. This is good news for Disney on several fronts.
For one, they invested an estimated $200 million in production and $150 million on advertising, so the Black Panther was a big bet. And from a cultural standpoint, this is the biggest opening weekend ever for a movie with a minority cast and director.
It’s no secret that Disney leads the way in making movies, still it’s reassuring to find their big bet on this particular film pay off in spades.
Verdict on DIS Stock
If you find American stocks to be reasonably priced at this time, than DIS stock may appear attractive. Studio business aside, things are going well, and even there, the company is still producing blockbusters.
But the Fox merger comes with significant integration risks. Any deal of that size is transformative, and if it doesn’t work, look out. More broadly, while Disney stock looks cheap compared to the market, remember its business is quite cyclical.
When the economy does hit a recession, Disney will underperform its peers. At this point in the economic recovery, I’m not real keen on picking up DIS stock unless it trades below a 15x trailing PE ratio.
At the time of this writing, the author had no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.