[Correction: This article was updated on Feb. 2, 2020, to correct the list of movies released in 2018.]
Since the beginning of October, Disney (NYSE:DIS) stock has jumped 10% as investors raved over the company’s new internet TV offering, Disney+. Meanwhile, the conglomerate’s fiscal first-quarter results, announced in January, also thrilled Disney stock bulls. But I think the company’s earnings actually support my bearish thesis on Disney stock.
On the surface, Disney’s Q1 results did indeed look quite stupendous, especially for a company of its size. The conglomerate’s top and bottom lines beat analysts’ average estimates.
Moreover, the revenue of its Studio Networks unit jumped to $3.76 billion from $1.8 billion, and so many people on Wall Street were extremely impressed by Disney+’s 26.5 million subscribers.
Even the revenue of the company’s Media Networks unit, which has been badly hurt by cord-cutting, rose an impressive 24% year-over-year, and the company’s total top line surged 36% YoY.
But underneath the surface, the results were actually quite ominous. The company’s “income from continuing operations before income taxes,” which excludes both charges and profits from the assets it acquired from Fox Corporation (NASDAQ:FOX) last year, tumbled 23% YoY to $2.6 billion.
Even excluding restructuring and impairment charges likely related to the Fox deal, along with amortization charges for its takeover of Hulu, Disney’s operating income fell 4.7% YoY. Further, the company’s cash from operations dropped to $1.6 billion in Q1 from $2.1 billion during the same period a year earlier.
Blockbuster Movies Boosted the Results
But wait, there’s more. The comparisons listed above would have been even worse (actually, much worse) if Disney’s movies at the end of last year weren’t so much more popular and lucrative than those it released at the end of 2018.
At the end of last year, it released two blockbusters, Frozen 2 and Star Wars: Episode IX. At the end of 2018, its releases included The Nutcracker and the Four Realms, Ralph Breaks the Internet, and Mary Poppins Returns. Anybody who is even the least bit familiar with popular culture will immediately see that Disney made much more money from movies at the end of 2019 than at the end of 2018.
Why Are Profits Falling?
Disney’s profits are getting hit by cord-cutting, lower ad revenues and the losses being piled up by its streaming assets. Higher interest costs, driven by the debt it took on to finance the acquisition of the Fox assets, is also playing a role.
ESPN recently reportedly generated $10.3 billion of revenue annually, largely from the $9 per month that Disney receives from cable companies for each household whose cable package includes the channel.
But ESPN’s subscriber base tumbled 4.5% YoY in Q1, versus a 4% YoY decline during the previous quarter and a 2.5% drop in the quarter before that. Meanwhile, the station’s ad revenue also sank 4.5% YoY in Q1.
The news also isn’t great for Disney’s other traditional TV assets. The company did not appear to break down the revenue of its cable networks and broadcasting channels excluding the Fox assets/ But Disney company noted that the financial results of its legacy broadcasting business had fallen YoY in Q1.
Meanwhile, the Q1 operating loss of the conglomerate’s Direct-to-Consumer and International unit, which includes the streaming businesses, came in at $693 million. During the same period a year earlier, the unit’ s operating loss was $136 million.
In Q2, Disney expects the unit to generate an operating loss of $900 million. Finally, the conglomerate’s net interest expense jumped to $283 million last quarter from $63 million during the same period a year earlier.
The Bottom Line on Disney Stock
The profits of the company’s TV assets are sinking, while its streaming assets and its interest costs are weighing heavily on its bottom line. So far, those facts have largely been buried by the Fox deal, the success of its movies last quarter, and excitement over Disney+.
Later on this year, the movie comparisons will not be nearly as favorable, its cord-cutting losses will accelerate, excitement over Disney+ will fade, and the positive comparisons generated by the Fox deal will be eliminated. As a result, the Street will become less enamored with Disney, causing Disney’s shares to decline.
As of this writing, the author did not own shares of any of the aforementioned companies.