Investors love so-called Sleep Well At Night “SWAN” stocks. When a stock provides consistent dividends and solid performance, it helps an investor to relax. Disney (NYSE:DIS) stock has also been inducing drowsiness lately, but it’s been no Sleeping Beauty for shareholders. Since 2015, Disney stock has consistently traded between $95 and $120 per share.
Regardless of all the news that has happened since then, the stock has been unable to make any significant gains or losses. Political changes, trade wars, streaming competition, huge mergers, none of it has mattered to Disney’s shares.
At what point will Disney stock finally wake up from its slumber? Don’t count on early 2019 breaking the pattern, after another underwhelming earnings report, there’s little to look forward to until April.
So-So Earnings Haven’t Moved the Needle
Disney has struggled in recent years because of a lack of investor enthusiasm. It’s been hard to see the big picture. So often, the company puts up mediocre quarterly results, but talks up the business’ prospects looking out a year into the future. Things are always about to get better.
We saw that again with this most recent quarter. Earnings actually declined 3% from $1.89 to $1.84. Not to worry, suggests management, this is the cost of ramping up the streaming business, and will pay off heading into next year.
For now, however, Disney investors are stuck looking at a lot of red numbers. For Disney’s first quarter (the one that ends in December), revenues fell slightly. EPS, as noted above, dropped several percent. Cash flow from operations declined 6%, and free cash flow sank by 28%.
Looking on a segment by segment basis, there were some signs of positives. Parks, experiences and consumer products grew their revenues by 5%, and media networks surged 7%.
That was more than offset by a 27% plunge in studio entertainment and a 1% drop in direct to consumer revenues. That last figure is particularly worrisome, given that ESPN+ was ramping up this quarter. On the other hand, the studio entertainment number isn’t as bad as it looks, as Disney had a string of blockbuster movies in the same quarter last year making this year a difficult comparison period.
Direct to Consumer Is the Main Event
Many people, myself included, have classified Disney as a type of conglomerate. Between films, television, theme parks, branded merchandise, and so on, there is a lot going on. But Disney’s management is making it clear that the company is going all-in on its direct to consumer “DTC” play. From the latest conference call, CEO Robert Iger stated the following:
As you know, DTC remains our number one priority. Our corporate reorganization was designed to support our DTC efforts while providing a greater degree of transparency into our investment and our progress in the space. We remain focused on the programming as well as the technology to drive the success of our DTC business, and we’re thrilled with the continued growth of ESPN+.
So how is the DTC business going? Recently, Disney restated its operating results for recent years to break out the DTC division on its own. DTC includes Disney Plus, ESPN+, and international channels, among other things. For 2018, DTC, if it were a standalone unit, would have lost $738 million on revenues of $3.4 billion. Those numbers don’t look so great.
Obviously, however, the streaming services are just now getting going. Furthermore, Disney seems to have a solid launch in process for ESPN+. The company reported two million ESPN+ subscribers at the end of this quarter. They’ve managed to double that figure in just five months.
Of course, investors will remain skeptical until the main event, Disney Plus, launches later this year. On the conference call, management was quite coy, telling investors to wait until Disney’s investor presentation in April for more details on the DTC offerings. That will be a key event to watch for DIS stock going forward.
Disney Stock Valuation
DIS is trading at around 15x both trailing and forward earnings. Interestingly, analysts barely see earnings growing in 2019, probably due to the large costs associated with the DTC build-out.
A bull on DIS can make a decent case that the stock is cheap here. Imagine that DTC were merely breaking even, rather than losing nearly $750 million per year. Disney earned $10.9 billion in net income last year, so getting DTC just to breakeven would boost earnings by around 7%. That would get the forward PE ratio under 14x and show a nice trend in EPS growth. Assuming DTC turns positive in 2020 or at the latest 2021, you can build a nice growth narrative.
There’s a reasonable chance this will play out. However, I don’t think analysts are going to give DIS stock much credit until the Disney Plus subscriber numbers start coming out.
Disney is betting heavily on this streaming strategy, and they face notable competition. Disney could come in and crush the competition. Or alternatively, perhaps Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN) have stronger moats than anticipated and DTC will fail to take off.
There’s a great deal of execution risk both with DTC and the implementation of the 21st Century Fox acquisition.
DIS Stock Verdict
I expect DIS to keep trading sideways in a muted range in coming months. Until investors have more clarity into how quickly the DTC channel will start making profits, Disney stock will be trading under a cloud.
You can make the argument to buy now, as shares should rally once investor confidence rises. But the big DTC-focused investor presentation isn’t until April, and it won’d be until the second half of 2019, if not later, before meaningful subscription numbers arrive.
At 15x earnings, DIS stock seems reasonably priced, but don’t forget that it faces more recession risk than many of its peers. Combine with a rather modest 1.6% dividend yield, and Disney stock isn’t a huge bargain at this point.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.