Disney Valuation: Underpriced Value Play?
Guest post by Reddit user u/k_ristovski
Welcome Back Everyone!
Today is a little bit different kind of post, today we have a guest author u/k_ristovski of Reddit. He has a Youtube channel here where he does regular stock valuations. I highly recommend checking him out and giving him a sub!
With that said let’s dive in!
Disney is one of the largest brands out there and the company has been seen as one with a moat for a very long time.
The goal of this post is to analyze the company's fundamentals and provide insights into the business fundamentals, financials as well as valuation. Feel free to disagree with the analysis and share your views.
Let's get started!
As always, link to the video for those who prefer to watch:
Share price performance & dividends
If we take a look at the last 5 years, the performance isn't great, down 7%, way below the S&P500 performance. Up until mid-2020, the company was a dividend-payer, so if we take the dividends into account, the return would be close to -2%. As of mid-2020, due to the pandemic, they've decided to change their dividend policy and stop paying dividends. In case the company decides to go back to paying dividends, the yield would be somewhere around 2% (based on the current share price).
The two main divisions
The company is currently organized into two divisions and understanding each one is important before we can make any rational/informed assumptions about the future.
Disney media & entertainment distribution - Division #1
This is their largest division contribution almost 70% of the total revenue. It grew from a bit over $30b in the financial year 2017* to over $50b in the last twelve months ending March 2022.
*Disney's financial years end in September and start in October the year before.
However, in the same time, the operating margin of the division is down from 30% to 10%. To better understand that, we need to go one layer deeper. This division has three main segments
a) Linear Networks (ABC, Disney, ESPN, National Geographic, Star) with an average operating margin of 31% in the last 5 years
b) Direct-to-consumer (Disney+, ESPN+, Hulu, Star+) with an average operating margin of -17% in the last 5 years
c) Content sales/Licensing (theatrical distribution, home entertainment (DVD/Blu-ray), Music distribution) with an average operating margin of 30% in the last 5 years
Now, we all know the streaming war going on with Netflix and Amazon Prime and Apple Plus TV, and Disney/Hulu. Direct-to-consumer stream is the reason behind the decrease in the operating margin of this segment. It has grown significantly in the last 4 years and since it has a negative operating margin, it brings down the margin of the entire division. Of course, the margin has been improving over time.
So, what can we expect from this division in the long run? The Linear Networks and the Content sales/licensing are both relatively mature segments with limited growth ahead, but high margins. The direct-to-consumer is high growth in terms of revenue, but the margin is yet to catch up. Looking into all the competitors, I don't see any chance that the operating margin gets anywhere close to the 30%. So in my forecast, I feel comfortable using a 25% long-term operating margin. What this means is I'm starting with the 10% and slowly increasing that over time.
Disney parks, experiences, and products - Division #2
This division contributes the remaining 30% of the revenue and it is related to the theme parks (Florida, California, Paris, Hong Kong, Shanghai), Disney Cruise Line, Disney Vacation Club, National geographic expeditions, Disney resort, and spa. Not only that, but here is also the revenue that Disney earns by licensing trade names, characters, visuals, and other IP to manufacturers, game developers, and publishers, as well as the sale of branded merchandise.
This is the division that got impacted significantly in 2020. The revenue went from $23b in 2017 to $26b in 2019 down to $17b in 2020 and $16.5b in 2021. Not only that, but the margins went down from 24-25% to under 3%.
As the world is going back to normal, this division is recovering as well, the LTM sales are almost $24b and the operating margin is at 22%. This amazing recovery in such a short period of time indicates the strong brand around the company.
Historical financial performance
If we look at the annual report, the combined financials are not equal to the sum of the two divisions. When looking into the individual divisions, what's not taken into account are the restructuring expenses that Disney had (over $5b in 2020 due to the pandemic) that are not allocated to any division to provide a better view and not distort the division's profitability. The same goes for the goodwill impairment and certain expenses that are related to the 21st Century Fox and Hulu acquisitions.
The balance sheet doubled in size in the last 5 years (roughly from $100b to $200b) majority of that due to the acquisitions ($50b goodwill, $10b other intangible assets) and their investments in content assets (>$20b)
On the other side of the balance sheet, it is quite clear how this was financed as there's a significant increase in debt of over $30b and there's a significant increase in the number of shares outstanding (from 1.5b to 1.8b).
The valuation
I used a DCF model to estimate the company's value. The assumptions are listed below:
Revenue growth: 15% for the next 12 months, followed by 6% in the 4 years after that and declining over time to 2.91%. The analysts are forecasting roughly 23% for 2022 and 12% for 2023. However, as the last public data is up until Q1/2022 (which is half of the financial year 2022 for Disney), part of this growth is already in the financials and included in my starting point.
Operating margin: Looking into the various divisions, a long-term target of 25% seems reasonable. Of course, this is highly dependent on the recovery of the DPEP division (which is on track) and the profitability of their Direct-to-consumer segment. In my model, I'm expecting the margin to increase slowly over time, reaching 25% in 8 years.
Discount rate: Currently 8.37% (based on WACC) increasing to 9.64% over time (also due to the fact that the FED is raising the interest rate)
Outcome: $89.4 (Current share price $96.08)
*Note: In the DCF calculation, the outstanding equity options and the minority interest are also taken into account.
What if my assumptions are significantly wrong?
Based on the assumptions stated above, the revenue will grow by 78% to $138.1b in the next 10 years and the operating margin will reach 25%.
Let's take a look at how the valuation of the company (per share) changes based on different assumptions related to the revenue 10 years from now and the operating margin:
It is worth mentioning that historically, Disney has almost always traded at a premium over the intrinsic value as it is seen as a bit more safe investment due to the brand behind it.
company and feel free to provide feedback regarding my analysis, that is always appreciated :)
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