Millions of people visit a Walt Disney (DIS 2.17%) theme park every year, and its movie studio business is one of the most profitable in Hollywood. But across all its business segments, the House of Mouse hasn't posted the financial results investors are looking for, which has sent the stock down almost 60% off its previous highs.
The stock is either the buying opportunity of a lifetime or a value trap. At first glance, some investors may intuitively sense a buying opportunity. After all, we're talking about a company that has been entertaining families for nearly a century. But let's find out exactly what is driving the stock down, and what Disney is doing about it, before rushing to buy Disney shares.
Weak earnings and subscriber totals are weighing on the stock
Overall, Disney appears to be doing fine from a revenue standpoint. The top line increased by 8% year over year through the first nine months of the fiscal year (ended July 1). But weak performance on the bottom line has been a red flag. In the first three quarters of fiscal 2023, Disney's adjusted diluted earnings per share fell 9% year over year to $2.94.
Data by YCharts
The weak earnings results point to two problems at Disney: weak advertising revenue at Disney's linear media networks, including ABC, and operating losses in the direct-to-consumer segment, which includes results from Disney+, ESPN+, and Disney's majority stake in Hulu.
The company's linear networks generate over a quarter of the company's revenue but suffered a 7% year-over-year decline in the fiscal third quarter (ended July 1). This not only reflects a weak advertising market, but also the ongoing cord-cutting trend that is forcing brands to shift their ad budgets from cable networks to digital media platforms. This is a long-term headwind that will continue to pressure revenue growth in Disney's broadcasting and cable networks.
The direct-to-consumer segment has the opposite problem. This segment is growing revenue but reported an operating loss of $2.2 billion through the first three quarters of the fiscal year. However, the segment's operating loss was cut in half in the recent quarter, as management focused on reducing costs.
Still, Disney+ faces more important challenges. Subscribers in the U.S. and Canada fell 1% from April 1 to July 1, while global subscribers grew just 1%, excluding the India-based Hotstar service. This is going to draw a negative comparison on Wall Street to streaming leader Netflix, which has more than twice as many members as Disney+ but is growing much faster -- and turning a healthy profit to boot.
Disney has options to boost the stock price
The bright spot at Walt Disney right now is the Parks, Experiences, and Products segment -- its largest revenue source. Through the first three quarters of the fiscal year, segment revenue grew 17% year over year to $24.8 billion, while operating profit totaled $7.6 billion, up 20%.
The strong recovery over the last three years in the Parks and Experiences segment, which includes revenue from Disney's cruise line fleet and consumer products, reveals that Disney's brand power can still draw a crowd. Management certainly sees it that way. The company just announced it will spend $60 billion over the next 10 years to expand and enhance the parks and cruise fleet. This comes on top of recent reports that Disney has held early talks with Nexstar Media Group about selling ABC and its owned local affiliate networks.
Disney released a statement on Sept. 14 stating that it is "open to considering a variety of strategic options" for its linear businesses, but it has made no decision yet on the future of any property.
That said, these are encouraging developments, because all an investor can ask of management under these circumstances is it makes rational capital allocation decisions to turn things around, and it appears to be doing just that.
Disney has valuable entertainment brands, but the long-term growth potential of those assets is being diluted with legacy networks that don't have bright prospects as advertising revenue shifts to digital media. Moreover, Disney could use proceeds from asset sales to pay down its $47 billion of debt on its balance sheet, another issue weighing on the stock while profits are down.
Although parks and cruises are not immune from soft periods of demand, the parks have been a steady source of growth for many years (except for the pandemic, of course). It makes sense to double down on your largest and most profitable business (theme parks and cruises) while exploring alternatives for the weakest link (cable networks).
Weighing the pros and cons of Disney stock
There are good reasons the stock is down. Disney has got work to do financially. Despite these problems, the profitable growth at the parks is a telling indicator that the appeal of Disney's characters is still intact.
I would be concerned if the parks were showing financial difficulty from weak traffic trends, but that's not the case. So I would look at the discounted share price as a buying opportunity, especially ahead of potential asset sales and investments in the parks and cruise businesses.
