Disney Stock: Can Direct-To-Consumer Growth Justify Current Valuations?

Summary

• Disney has transformed itself into a direct-to-consumer powerhouse. It's trying to position itself as a growth stock.
• Its current valuation also seems to have reflected its transition. Nonetheless, DTC is still a relatively small segment compared to its total revenue.
• We discuss whether Disney stock's current valuation is justified.
• Looking for a helping hand in the market? Members of Ultimate Growth Investing get exclusive ideas and guidance to navigate any climate. Learn More »

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Investment Thesis For DIS Stock

The Walt Disney Company (NYSE:DIS) has transformed itself under CEO Bob Chapek into a "growth" player. It has astutely used the COVID-19 pandemic to drive its transformation into a direct-to-consumer (DTC) powerhouse. The company suspended its dividend when the pandemic hit early last year. The company has also emerged strongly from the pandemic as the reopening cadence gained traction. Notwithstanding, DIS is in no hurry to reinstate its dividends nor stock buybacks. In addition, it's also "not entertaining" such moves until it recovers its A+ credit rating (currently at BBB+).

Despite that, investors have cheered the company's transformation to pursue higher growth strategies. Particularly they like CEO Bob Chapek's aggressive DTC move to compete with its streaming video-on-demand (SVOD) and ad-supported video-on-demand (AVOD) competitors. Some investors may not be aware, but DIS is a leading player in both markets.

We discuss whether the company's aggressive growth strategies justify its stock's current valuation.

DIS Stock YTD Performance

DIS stock YTD performance (as of 1 November 21).

DIS stock has been stuck in a year of consolidation after reaching its all-time high (ATH) in March. As a result, its YTD return of -6.1% has significantly underperformed its leading SVOD and AVOD peers. Despite having a topsy-turvy year so far, even ROKU stock is slightly ahead with a -4.3% YTD return. Moreover, DIS stock also trails Netflix (NFLX) stock and Alphabet (GOOGL) (GOOG) stock significantly. Therefore, it has been an underwhelming year so far for Disney stock.

How Has Disney's Business Performance Been So Far?

Disney LTM revenue and EBIT. Data source: S&P Capital IQ

Disney LTM and quarterly operating margin. Data source: S&P Capital IQ

Disney reported a last-twelve-months (LTM) revenue of $63.6B in FQ3. Disney has been recovering its revenue remarkably well, buoyed by the reopening traction observed in its theme parks. Notwithstanding, its revenue remains a distance away from the high of $75.2B achieved in FY19.

Moreover, we also observed the stellar recovery in its operating margins on both LTM and quarterly basis. Disney's quarterly operating margins are still some way off the highs of FY19. Nonetheless, its recovery has been encouraging.

Disney quarterly revenue segments YoY comparison. Data source: Company filings

Disney segments' quarterly operating income YoY comparison. Data source: Company filings

The recovery in parks, experiences, and products is encouraging. Despite that, it remains well below Q3'19's revenue of $10.45B. Therefore, we can expect this segment to continue its recovery as the reopening cadence unfolds. However, the recent surge in COVID-19 cases in China has once again thrown a spanner in the works. CNBC reported that "Shanghai Disney Resort suspended entry late Sunday and asked visitors to get coronavirus tests, just hours before the night of Halloween." The cadence in China is expected to be encounter unforeseen disruption due to China's "zero-COVID" policies. Notwithstanding, we believe that these disruptions are transitory. In addition, the company also announced today that it would reopen on Wednesday after the completion of quarantine requirements.

Notably, DTC has been the bright spot here. We believe that the company's aggressive growth strategies in DTC have been instrumental in the re-rating of its stock price. In FQ3, DTC revenue grew 57.2% YoY.

Notwithstanding DTC's rapid growth in 2021, it's still a loss-making segment. The segment continued to report operating losses in FQ3. Nevertheless, the losses have also been significantly reduced. The company's Media and Linear Networks segments continue to drive revenue and profit for Disney. However, operating profit recovery has been lackluster. In addition, these segments are unlikely to provide the gangbusters growth that DTC can potentially afford. We think DTC is the bright spot in an otherwise "slow-moving" portfolio. But, we are not sure whether that's enough, given that it remains a relatively small segment compared to Disney's total revenue.

Analyzing Disney's DTC Growth Momentum

Disney DTC paid subscribers. Data source: Company filings

DTC average monthly revenue per paid subscriber. Data source: Company filings

DTC's growth has been pretty robust over the last four quarters. Its total subscribers base increased from 120.6M in FQ4'20 to 173.7M in FQ3'21. Although the growth was broad-based across Hulu, ESPN+, and Disney+, the latter took the accolade for driving the sheer growth numbers. As of FQ3, Disney's 173.7M subscribers base is getting closer to Netflix's massive subscribers base.

Netflix paid subscribers worldwide (in millions). Data source: Company filings

While Netflix is still well ahead with 213.56M subscribers in FQ3, Disney expects to reach between 230M and 260M of Disney+ subscribers by FY24. Nevertheless, its average revenue per subscriber is still relatively small. Therefore, Disney+ needs to scale rapidly to gain efficiencies and justify its growing content slate. Notwithstanding, DTC depends on Hulu and ESPN+ to help alleviate the losses over at Disney+ as it scales. We believe Disney's DTC segment has a robust strategy. CEO Bob Chapek is sanguine of DTC's ongoing prospects, despite guiding for "low single-digit millions" subscribers in FQ4. Its weak guidance prompted a scare in the market as consensus estimates pointed to 17M in Disney+ subscribers in FQ4 previously.

Notwithstanding, Chapek believes that its varied DTC offerings provide them a competitive edge over Netflix's "one-size-fits-all" approach. Moreover, he emphasized that the company's go-to-market strategy helps them to localize their DTC offerings well. He articulated:

I think one of the reasons we're successful in India and in the Southeast Asian markets increasingly is the fact that we're really tuned into why those markets are different. Our whole approach with our direct-to-consumer offerings across the world is that 1 size does not fit all. That's why you see us go to market with different propositions, different utilities and different offerings. And in the case of Hotstar, we've got unparalleled content. We've got sports. We've got 18,000 hours of local content that we create a year for that market. (from Goldman Sachs 30th Annual Communacopia Conference)

We remain confident of Disney's DTC strategy. We like its SVOD and AVOD approach and leveraging on the ESPN+ cash cow to drive growth and sustain the segment as Disney+ scales. eMarketer expects Hulu to maintain its market leadership in AVOD ahead of YouTube and Roku. It estimates that Hulu's Connected TV (CTV) ad revenue will increase from $2.17B to $4.82B by 2023. It represents a remarkable CAGR of 30.5%. Hulu operates in a fast-growing AVOD segment where Roku and YouTube have also reported gangbusters growth lately.

In addition, Chapek also emphasized that subscribers numbers are not linear. He added: "What we're finding out, as you've seen from our last several quarters, is that these numbers tend to be a lot noisier than a straight line. They're not a straight-line relationship quarter-to-quarter. And indeed, we've seen some of that this current quarter."

Therefore, we think investors should consider the longer-term prospects and guidance from the company for its DTC segment. We believe the company remains on track to meet its long-term guidance. In addition, they have executed its DTC strategy with aplomb.

J.P. Morgan also weighed in, as it emphasized the non-linearity of its subscribers' growth. It encouraged investors to adopt a longer-term outlook on Disney+ prospects. The firm added: "Given the unpredictable nature of subscriptions, and that management generally does not provide guidance on subscriber growth, it is to be expected that Disney+ may not always hit consensus expectations each quarter. We remain very encouraged by the growth outlook for Disney+ and are not concerned with this modest shortfall versus expectations."

So is Disney Stock a Buy Now?

DIS stock EV/NTM EBITDA 3Y mean (pre-COVID).

DIS stock EV/Fwd EBITDA valuation trend. Data source: S&P Capital IQ

Disney stock is trading at an EV/NTM EBITDA of 24.3x. Notably, it's way ahead of its 3Y pre-COVID NTM EBITDA multiple mean of 11.37x. Therefore, we think DIS stock's valuation seems to have baked in the optimism on its DTC growth, as well as the recovery of its Parks segment. It looks like at least three to four years of EBITDA growth have been priced into DIS stock at the moment.

While DIS stock has a relatively robust long-term price uptrend, we aren't sure whether its current price would help investors to outperform the market moving forward.

Therefore, we rate Disney stock at Neutral for now.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of NFLX, GOOGL, ROKU either through stock ownership, options, or other derivatives. 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.

Comments

[valuinvstr99]

JR Research
What is your take on Max Greve's 11/2/21 SA article "Disney's ESPN Problem May Finally Be Catching Up To It"? If I'm getting the correct message from both articles, they appear to conflict on the ESPN role in the DTC mix/profits.

[La Marque]

A very optimistic article. My 2 cents is that DIS is worth about 120 after the pandemic runs its course. Disney's content is all over the place, being narrowly marketed by niche. It is a very capital expense strategy to try to be all things to all consumers.

[Rogue Trader]

@La Marque Capital intensive to be all things to all... Amazon? I think that if you're generating good ROI go ahead and invest the capital while financing is easy. And I really do think that in 10 years we'll applaud Disney for its transition.

[La Marque]

@Rogue Trader Pardon me for disagreeing. Disney at today's prices is dead money unless one is trading with the greater fool theory in mind. Disney does not have a cash cow service like AWS to fund its fantasies. Entertainment and content generation is very capital intensive relying upon fickle consumer tastes, not like a basic digital infrastructure business.

[Rogue Trader]

@La Marque Fair comment but I too disagree :) Content generation isn't new for Disney, it's always been producing it. Going forward, it'll be business as usual just with the TFCF addition.

AWS wasn't a core operation for Amazon and it needed to invest heavily to create it. Disney's DTC is similar in terms of its scalability and profitability.

Moreover, parks are highly cash generative for Disney. Perhaps not as much as AWS but nothing to sneeze at. Disney has been generating $5 bn to $9bn FCF for a long, long time now.

[Clauser1960]

In the US, a monthly Disney subscription costs less than two hours of a baby sitter......

[VoiceofSanitySometimes]

Too much emphasis on the pipe instead of the material flowing through it.

If Disney keeps making top quality content that people want to consume, I have absolute faith that no one is better than Disney at monetizing that demand.

That is the big question -- can they keep creating the best content on the planet? They have a solid history of delivering on that promise, but the last year has seen a few disappointments too.

[Rogue Trader]

@VoiceofSanitySometimes I'm not at all sure the quality matters as much as we think. Disney's content is, as you say, unarguably the best on the planet. In my opinion, Netflix's is very poor. I struggle to find things to watch on Netflix never mind watching more than once and I see many people around me thinking the same. The rewatchability is essentially the key to long-term recurring revenues and will make or break unit economics in both customer acquisition and content production. Netflix's quality seems to suffice for now. It'll be interesting to see if people churn from NFLX once HBO and DISCA merge their IP.

By the way, I do genuinely think that Disney will keep it up.

[nerd_rage]

@VoiceofSanitySometimes The difference between DIS and NFLX is that with big brands, DIS can apply its content budget more efficiently.

To stumble across one Squid Game hit, NFLX has to spend billions on random content from all over that mostly will just disappear into a black hole. They have no good way to predict what money will be wasted and are just throwing darts at the wall.

But DIS has a reasonable expectation that anything called Star Wars or Marvel will at least not disappear without any attention paid to it at all. That means DIS can put a larger budget and more attention into the smaller roster of content they make. The result is that they appear to have far higher quality overall than NFLX and I don't see why that would change since it's all driven by having brands or not.

NFLX needs some decent brands and DIS needs to expand into content that has appeal beyond kids and nerds. NFLX is trying to expand and DIS is being held up by the Comcast deal but are moving forward overseas by integrating Star with Disney+.

Both have viable strategies, both know what they need to do and both are doing it. I'm very confident in both.

[wwloon32]

@nerd_rage Unfortunately for Disney, each production cost $200m to produce at average. The whole series of Squid Game cost $20m, and that series alone has larger impact on youtube than GoT which has 10 years run of series.

Which means, Netflix can afford to have hundreds of darts to throw with and will surely hit one or two. Disney can only throw thirty darts and that's it. If it misses, it miss.

It did miss. Which is why their Disney+ subs acquisition is now faltering.

I am itching to write an article on this one.