Disney: Stale Sentiment And A 0% Dividend

Sep. 08, 2021 4:21 PM ETThe Walt Disney Company (DIS)22 Comments2 Likes

Summary

  • Management sentiment predicts another quarter of consolidation - an opportunity cost for DIS investors.
  • The boost in the stock price over the past few quarters can be explained by a recovery in management sentiment and a return to positive earnings; that phase is over.
  • Disney's industry is experiencing strong growth but Disney itself lags the industry, further pointing to the opportunity cost of this stock.
  • I recommend a two-week options play, rolled over the next two months, for playing DIS's predicted weakness.
  • I do much more than just articles at Exposing Earnings: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
Red Zero Percent #5
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Someone recently asked me about Disney (NYSE:DIS). To my surprise, I haven’t written about Disney (DIS) since pre-pandemic times. Interestingly enough, the previous strategy I outlined – buying DIS stock before animated movie releases – is likely no longer effective, due to movie theaters having taken the backseat to streaming.

Let’s investigate the “new” Disney, starting from the recent earnings report. Like many mature stocks, DIS tends to be driven by its earnings reports. Anyone can see that Disney’s earnings have been weak relative to before the pandemic:

The company went from posting nearly $14B in profits per year to -$4B per year. While earnings have recovered, they are at a middling $1B per year, at present.

But a deeper, less obvious earnings factor is the management sentiment, which can be used orthogonally to other analytical factors. We’ll discuss this first.

Disney Sentiment Analysis

Natural language processing ("NLP") is a form of artificial intelligence that allows our computers to read text in our place. In recent years, it has been applied to financial literature to make predictions for stock and economies. I employ it in my earnings analyses to derive management sentiment, a method that has proved useful for me in predicting stock prices.

I ran such an analysis over Disney’s recent earnings calls, deriving sentiment scores that could be compared across quarters. Here is what I found over the past year or so: First, sentiment was net negative for Disney prior to Q3, 2020. Sentiment score, as defined as the ratio of positive forward-looking statements to negative ones, rarely are net negative, as management tends to be overly optimistic. The pandemic seemed to have a greatly negative effect on management sentiment before Q3, 2020.

As sentiment turned positive in Q3, 2020, it remained positive, slowly returning to the pre-pandemic average sentiment, by Q2, 2021. The most recent quarter, Q3, 2021, showed a 5% drop in sentiment, which means that sentiment this quarter is roughly the same as that of last quarter – and thus we should expect similar gains in the stock, all things being equal. Here are the three phases labeled in DIS’s chart.

(Source: StockCharts)

Interesting is that although the recent sentiment scores are higher, DIS made stronger gains during the period sentiment was returning to average. The best I can explain this is that management returning to optimism pointed to a bottom in the stock. Times of improvement often bring greater gains than times of stability, even if stable times offer numerically stronger numbers. Clearly, growth and recovery phases produce alpha to a greater degree than business-as-usual.

That has implications for the present quarter. With the return to normal sentiment, DIS stock trended sideways last quarter. As this quarter’s sentiment is roughly the same, the most immediate conclusion would be to predict the same sort of consolidation into the end of 2021.

However, I am a bit more bearish, for other reasons.

Disney’s Big Zero

Disney has a market cap of 0.3T, a size that precludes a simple summary. Indeed, a single thesis on a company that has its hands in so many industries is impractical. I find it is better to look at the numbers.

To me, the most relevant Disney number at this point is zero. Namely, the value of the dividend.

Studies have shown that companies tend to cut their dividends in two main situations. One is during relatively good financial health. The dividend cut is made simply to deleverage and improve the debt-to-equity ratio. These dividend cuts typically have little predictive power for the stock.

The second type of cut is performed in a reactionary manner. Poor financial performance prompts the company to cut the dividend in an effort to reduce the rate at which the balance sheet turns ugly. Interestingly, unlike cost-cutting, dividend cuts predict weak stock performance and thus should be considered warning signs to investors.

Disney’s dividend cut is of the second type. While the dividend cut itself is old news, the recent earnings report reignites the danger. Originally, Disney management declared that there would be no dividend for FQ1 and FQ2, implicitly pointing to a reestablishment of the dividend this quarter. However, the dividend did not come.

This shows investors two things. First, I believe it shows that the behind-the-scenes financials are likely still unhealthy at Disney. Second, it suggests that the speed at which Disney’s profits will recover has changed.

In the recent earnings call, management switched from an implication of a dividend coming at a certain point in a certain fiscal year, as they did last year, to pure vagueness, using the phrase, “for the time being” in discussing the lack of dividend and share repurchases. Management has therefore switched out expectations for uncertainty. While some investors might appreciate management being more honest by showing its lack of direction in regard to the dividend, lack of direction has been shown to lead to weak returns, as per studies in the financial lexical analysis literature.

If we turn to the analysts, we see expectations for a return to pre-corona EPS levels in 2022. The average predicted EPS for 2022 is $4.37, decently close to the 2019 EPS of $5.63. This implies a quick post-pandemic recovery.

The management indication that a dividend is not on the horizon points to the analysts being perhaps too optimistic here. Indeed, despite recent earnings growth, Disney’s earnings are still down 30% over the past five years, while its debt is up 10%. And this is within an industry that is growing at a rate of roughly 10% per year.

To me, this says that Disney is mispriced. Moreover, the weak financials relative to the industry and the dividend cut point to an opportunity cost. I think the best opportunity here is to use DIS as a short leg in a pair trade or as a general short hedge for a long-heavy portfolio.

Here’s my idea.

DIS Short Trade

My intended trade follows.

  1. Buy 1x Sep24 $180 call @ 3.88*
  2. Sell 1x Sep24 $185 call @ 1.79*
  3. Sell 1x Sep17 $180 call @ 3.17*

Net credit: $108

Close or roll over (more below) on Sep17

*prices are given at the time of writing, September 4th.

Here, we are short delta and long theta. That is, we stand to profit from both consolidation, which is what my sentiment analysis implies, and from a drop in the stock price, which is what Disney’s financials hint toward. In other words, as long as DIS does not rise, this strategy profits.

The risk involved from this strategy lies in DIS rising, as we are net short one call. This gives us unlimited upside risk. Not only that, but we also will need margin for this trade.

Regardless, from a risk/reward perspective, this play looks reasonable. DIS will need to rise close to $190 within two weeks before we begin to experience a significant loss. We can easily reduce our risk exposure by closing one of the short call options should DIS begin to rally.

As this strategy is based on my sentiment and financial thesis on Disney, this trade is good for two months (up to the month before the next earnings report, when stocks typically add momentum one way or the other). That is, you can roll this trade over four times, if you so desire. But I would continue using options two weeks out so that we can keep theta values high, allowing more profit from time decay.

Let me know if you have any questions about this strategy in the comments section below.

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This article was written by

Damon Verial profile picture
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Damon Verial is a statistical analyst who uses his skills to research stocks, options, and investment strategies. In addition, Damon is the writer of Copy My Trades, a trade-alert, subscription-based newsletter, available at his personal website. He is also the writer of Exposing Earnings, an in-depth earnings prediction service here on Seeking Alpha.

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Damon makes his living as a gap trader, an earnings trader, and an interday trader. In his free time, he writes for Seeking Alpha, where he focuses on seasonal investing, market timing, and earnings analyses.

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Damon has written several successful stock analysis algorithms, including algorithms that can predict gap closure, intraday patterns, and news overreactions. They will soon be publically available for subscribers.

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Damon’s undergraduate education was in statistics and mathematics at the University of Washington; his graduate education was in psychology at National Taiwan University. He currently lives in Fukuoka, Japan.


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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Short position through short-selling of the stock, or purchase of put options or similar derivatives in DIS over 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.

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