Disney (NYSE:DIS) is up almost 20% this year, and has become too expensive; avoid it for now. There is too much hype about its soon-to-launch new streaming service, Disney+. Disney stock already has this hype priced in.
Three metrics tell the valuation story. For example, Disney stock trades at 4.3 times EV-to-sales. This is 87% higher than the media sector average, according to Seeking Alpha.
Its dividend yield is 1.35%, whereas the sector average is higher at over 3.0%. And DIS stock’s free cash flow yield is 4.9%, but the industry is much better at 12.9%
Streaming Wars and Disney Stock
Disney’s fiscal third-quarter ending June was terrible. Although revenue was up 33% year-over-year, net income fell 51%. Its cash flow from continuing operations was negative, and so was free cash flow.
The same general deterioration was true of its nine-month cumulative results. The losses were due to its integration of 21st Century Fox movie studio it acquired earlier this year.
Disney stock is primed for November launch of its streaming service called Disney Plus. It will cost $7 per subscriber per month or $70 with an annual subscription. This is half the price of HBO Now and a big discount compared to Netflix (NASDAQ:NFLX). It will also offer a triple bundle, including Hulu and ESPN Plus, for $12.99 per month, the same price as Netflix.
Analysts call this service the future of Disney. One analyst at Needham laid out six reasons why Disney will win the streaming wars with NFLX, AT&T (NYSE:T) – which owns HBO and other streaming companies. Other analysts cite statements from Disney that it expects to have a subscriber base of 60 to 90 million in four years by 2024.
Don’t Pay for Growth
But these projections will apparently add only $5 to $7.5 billion to Disney’s revenue by 2024. Disney had $65 billion in revenue in the last 12 months. Revenue for the year to September 2020 is forecasted to be around $89 billion. So at best, the streaming services would add just under 10% of revenue by 2024.
Is that worth paying 87% higher for sales compared to its peers? Or over twice for its cash flow than the sector average? I don’t think so. One analyst at Morgan Stanley is only “incrementally bullish” based on the streaming service hitting its numbers. Even the Needham analyst suggested that most of Disney Plus’s subscriber growth would come from Netflix users, not new growth.
Margins May Not Work
Morgan Stanley suggests that Disney will reach 30% long-term margins with its streaming service. In fact, concerns about cannibalizing its legacy movie, parks and TV channel businesses are overblown. The future is streaming and that’s where Disney will be.
The problem with this analysis is that Disney makes only 20% operating margins with its businesses today. In fiscal Q3 ending June, operating income was $3.96 billion on $20.2 billion in revenue. That works out to 19.6% operating margins. There is no reason why a competitive streaming business inherently has 50% higher margins than its existing businesses.
Netflix made $706 million on $4.92 billion in revenues in its most recent quarter. This is an operating margin of just 14.3%. So the Morgan Stanley analyst’s view that Disney will make 30% operating margins seems high.
Will Streaming Services Take Off?
Barron’s magazine just published an article titled “It’s Crunch Time for Disney+. Consumers May Not Be Budging.” The article expresses skepticism that Disney may not win over new subscribers with the new streaming competition it faces.
Four new streaming services are set to start from November and the spring of 2020 from Comcast (NASDAQ:CMCSA), WarnerMedia, Apple (NASDAQ:AAPL) and of course Disney. In addition, a classic TV arms race of sorts has started, according to the Wall Street Journal. Content costs are soaring.
Bottom Line on Disney Stock
Disney stock is still too expensive, even though it is 10% off its peak. Going forward, don’t expect that the high valuation for Disney’s growth will pay off. It would be better to wait for a deeper dip in the stock to buy-in.
It’s like the old saying “buy on the rumor, sell on the news.” The news is occurring in November when Disney+ launches. Better to wait and see who appears to be the winner in the coming streaming war.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers a two-week free trial.
