Summer Flops and Hits and Cord Cutting. The Walt Disney Company (NYSE:DIS) premiered its latest summer blockbuster, the Steven Spielberg-directed fantasy adventure, The BFG, to mostly good reviews over the Independence Day weekend. However, like its big-budget 2015 film Tomorrowland, The BFG flopped, bringing in a paltry $26.1 million from both domestic and international audiences as it faced stiff competition from Disney's own (via Pixar) Finding Dory and Time Warner's (NYSE:TWX) The Legend of Tarzan.
While the success of Finding Dory, which has earned nearly $556 million globally, should salve Disney's BFG-related sores, the same cannot be said for ESPN, which lost another 1.5 million viewers in May, bringing its total viewer attrition to 10 million since 2013.
Dividend Impact and Outlook. The travails of its media properties comes against the backdrop of a tepid fiscal second quarter for Disney. Despite reporting a 4% increase in revenues in the 3 months that end on April 2nd, the global entertainment giant's adjusted earnings of $1.36 per share fell short of the Wall Street consensus of $1.40 per share. Consequently, the stock has languished in 2016, falling 7.1% compared to the 2.4% gain of the Dow Jones Industrial Average, of which Disney is a component.
Even as Disney's stock has taken its lumps, the company has continued to pay a dividend. With a yield of 1.45%, Disney's dividend is just about average for its industry. Investors who purchase $10,000 worth of Disney shares can expect $145 in passive income each year but the question has to be whether Disney is worth buying as a dividend stock.
In our view, Disney is a good dividend stock -- but investors probably shouldn't be buying it yet. Here's why:
Disney's financials remains robust. On a relative basis, Disney's financial ratios are either solid or in-line with the industry average, which is remarkable considering the large outlays involved in financing its films and maintaining and operating its vast array of recreational parks and resorts.
While Disney does have close to around $21 Billion in borrowings, it has over two dollars of equity to cover each dollar of these borrowings - and, more importantly, its Long-Term Debt to EBITDA is at just 1.23x, which is below the 2.0 threshold generally considered safe. In that regard, Disney is hardly over-leveraged and there is little reason to believe that debt repayments or servicing will impede its ability to make dividend payments.
Meanwhile, Disney's Free Cash Flow (the cash that it can elect to re-invest in the business or return to shareholders) grew by 12% in the first six months of fiscal 2016, bringing its total free cash flow to $3.2 Billion for the period - or more than enough to cover a year-and-a-half's worth of dividends. This is vital to dividend shareholders because it speaks directly to Disney's capacity to continue paying dividends - even more so than earnings per share since this measure can include non-cash items.
Naturally, Disney's ratios are affected by its revenue prospects and, in that sense, we're interested in seeing what its forward prospects will be like. This is where the impact of the success or failure of Disney's various entertainment properties will be felt. Currently, analysts expect Disney's revenues to grow by around 13% this year - but next year's revenues are only expected to grow by around half this rate. What's more, Disney's sales are only expected to rise by 10% on average over the next five years - or half its revenue growth rate from the past five years.
A lot of this has to do with ESPN: at the estimated $80 per year that it makes on each cable subscriber, the 10 million it has lost translates into an annual revenue impact of $800 million at current subscriber package prices. Moreover, given that Disney's operating income margin on its Cable Networks is 51%, this cascades into a $408 million reduction in its annual operating income. That's equivalent to around 3.5% of Disney's annualized Free Cash Flow - a not inconsiderable sum since Disney's annual dividend is at approximately $2.3 Billion.
There's also the direct and indirect impact of Brexit on Disney's European operations - particularly film production. The weaker currencies of the UK and the Eurozone might make film production cheaper - but Brexit also result in the loss of valuable tax credits (particularly Britain's 25%). Disney's parks could also be affected by a weaker travel and tourism environment as insecure consumers defer trips or cut down on visits.
The performance of The BFG notwithstanding, Disney does have a reliable stable of properties, particularly Marvel and Star Wars, both of which are Billion dollar hit producers. That said, investor sentiment is clearly lukewarm towards Disney and it is prone to negative sentiment arising from macroeconomic shifts and poor box office reports.
Ultimately, Disney remains a valuable stock and should be a staple of any dividend investors' portfolio. However, the mix of negative sentiment arising from cord-cutting, Brexit and tepid box office performance could mean a volatile next few months for the stock. In that sense, investors would be well-advised to wait until well after Disney's next earnings release (in August) before taking a position in the stock - with the benefit being a higher dividend yield.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.