Disney (DIS) is going through a transition. The company is facing problems in the media segment due to cord-cutting, and this is putting considerable weight on the stock. However, uncertainty can often generate buying opportunities for investors.
Content is king in the industry, and Disney is strong enough to continue thriving under the new TV parading. Besides, the stock is very attractively valued. At current prices, the stock is offering plenty of upside potential, especially with the new Disney+ service being launched later this year.
Changing The Narrative
Over the past few years, Disney has been focusing on defending its business model from the negative impact of cord-cutting. But the company is moving to the offensive now, and 2019 is looking like a pivotal year for Disney due to the 21st Century Fox (FOX, FOXA) acquisition and the launch of its much-awaited Disney+ streaming service.
The company is doing a great job with ESPN+ in the online segment. According to management, ESPN+ currently has 2 million paid subscriptions, double the number from just five months ago.
ESPN+ operates on BAMTech's platform, which has proved to be reliably stable during peak live streaming consumption and easily handled the volume of more than 0.5 million people signing up in a single 24-hour period. This same technology will power Disney+ when it launches later this year.
The teams working on content for Disney+ are mostly the same teams that have created massive successes for Disney, Pixar, Marvel, and Lucasfilm over the years, so the platform looks very promising in terms of both the user experience and the content itself.
Disney is having its Investor Day on April 11, and management is planning to demonstrate the Disney+ platform and showcase some of the original content it's creating for such platform on that date. If the market likes what it sees in Disney+, this could be a game-changer for DIS stock.
The Big Picture Remains Intact
Looking at the big picture, Disney is arguably the strongest player in the entertainment industry on a global scale. The company owns intellectual rights to many of the most valuable franchises in the world, and it builds brands around its characters and intellectual properties, monetizing them via multiple platforms at the same time: movies, TV shows, toys, entertainment parks, etc.
Consumers are moving away from cable and embracing the online TV paradigm, but that does not change the fact that content quality is the main success driver in the industry. In times when consumers face an abundance of options, they tend to gravitate towards the brands and franchises that they know well.
The content library for Disney+ looks clearly exciting. The platform will feature content from Disney Studios, Marvel, Lucasfilm and Star Wars, Pixar, and National Geographic. Disney is also producing exclusive content for Disney+, including a High School Musical show, an animated Monsters Inc. series, a Marvel live-action title, and a Star Wars production entitled The Mandalorian.
There is no such thing as a guaranteed success in the business world, but Disney owns enormously valuable content, and the company has both the brand differentiation and the technical resources to expand into the Direct to Consumer business successfully.
Changing industry dynamics are generating uncertainty around DIS stock, but such uncertainty is already reflected on market prices, and Disney is trading at remarkably attractive valuation levels.
The chart below shows the evolution of price-to-earnings, price-to-operating cash flow, price-to-free cash flow, and enterprise value-to-EBITDA over the past five years. Based on these metrics, DIS stock is clearly valued at the low end of the range by historical standards.
Besides, valuation is not just about looking at the main valuation metrics in isolation. The valuation metrics should be interpreted in the context of other return drivers, such as the company's financial quality.
The PowerFactors system is a quantitative algorithm available to members in my research service, "The Data-Driven Investor." This algorithm ranks companies in the market according to a combination of quantitative factors that include: financial quality, valuation, fundamental momentum, and relative strength. In simple terms, the PowerFactors system is looking to buy good businesses (quality) for a reasonable price (valuation) when the company is doing well (fundamental momentum) and the stock is outperforming (relative strength).
The algorithm has delivered market-beating performance over the long term. The chart below shows backtested performance numbers for companies in 5 different PowerFactors buckets over the years.
Data from S&P Global via Portfolio123
Companies with higher rankings tend to produce superior returns, and stocks in the strongest bucket materially outperform the market in the long term.
DIS stock is currently in the top bucket, with a PowerFactors ranking of 88. Fundamental momentum is not very exciting at 49.25, which is mostly because growth has decelerated in recent quarters. Relative strength is at a solid 74.85, but where Disney really excels is in financial quality (91.1) and valuation (83).
In other words, when considering long-term return drivers such as financial quality and valuation, Disney looks like a remarkably attractive investment.
The company is well-positioned to successfully enter the streaming business with Disney+ over the coming months, and this could be a powerful trigger for the stock.
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Disclosure: I am/we are long DIS. 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.