- Walt Disney's investment in BAMTech is great move to counter cord cutting worries around ESPN.
- Disney has strong cash flows which will allow it to continue returning capital.
- With an attractive valuation and strong growth potential, Disney stock is a good buy.
Walt Disney (NYSE:DIS) stock has lost more than 9% YTD, becoming the worst performing Dow stock in the current year. In its latest earnings, the company delivered a convincing beat on both revenue and earnings. But even this good earnings report was not able to cheer the market with Disney stock continuing its sideways trend. The cord cutting worries surrounding the ESPN franchise have drowned out all the positive news. While cord cutting worries are reasonable, all is not lost at Disney. Here are three reasons why Disney Stock is still a good buy.
Reason 1: Betting On Streaming Business
With the arrival of over the top and digital broadcasters like Netflix and Hulu, the cable network business has faced significant challenges. Many viewers are doing away with their cable connections and Switching to streaming services like Netflix. ESPN has lost more than 10 million subscribers in the last three years alone, which is quite worrying, as ESPN contributes a major chunk of Media Networks revenue. And in the latest quarter, the media networks segment contributed more than 40% of Disney's revenues.
However, there may be a silver lining to this decline. A recent report by SNL Kagan, a service provided by S&P Global Market Intelligence sees a moderation in cord cutting in the next few years. Also, Disney is preparing to enter the streaming business by buying a stake in BAMTech, a streaming service controlled by MLB and NHL. Disney has invested around $1 Billion for a 33% stake in the company.
Disney, through ESPN, will use BAMTech to live telecast sports events. But these events will be the ones which are not being telecast on ESPN TV channels, i.e these won't be mainstream sports events. This will help Disney not only to prevent cannibalisation of its TV viewers but also target a new group of viewers. BAMTech has recently entered into a partnership with Silver Chalice to live stream college sports content. Disney is recognising the potential of streaming services and is taking a calculated bet. Apart from BAMTech, Disney has also announced that AT&T DirecTV will offer subscription packages for ESPN, ESPN2 and other Disney channels in its upcoming DirecTV OTT service.
Reason 2: Strong Growth Potential From Studios And Parks
Disney has a strong momentum from its studios and Parks business. The last few quarters have been great for Disney's studio divison. Studio divison has shown tremendous growth in the first nine months, with revenue growing at 37%. Of the 5 top grossing movies in 2016, four of them were produced by Disney. And this is not the case only for this year. The studio division has been doing great over the past decade. To quote Disney CEO Robert A. Iger from the Q3 earnings call:
" Since our 2006 acquisition of Pixar, we've released 29 films under the Pixar, Marvel, Lucasfilm and Disney Animation banners. The average global box office for these movies is about $800 million. 29 films with an average box office of almost $800 million is an astonishing achievement..."
And Disney already has a strong lineup of movies to be released in 2016, most notably Star Wars:Rogue One which is slated for release sometime in December.
On the Parks front, many analysts are expecting strong performance from the newly opened Shanghai Resort. The Shanghai park was opened on June 16 and has seen more than 1 million visitors since then, with the occupancy rate around 95%, according to the Disney CEO. The 1000 acre resort is Disney's largest theme park and has a huge catchment area with around 300 million people living within three and a half hour cab or train drive. And with rising affluent population in China, the Shanghai Resort will be a strong driver of growth.
Reason 3: Strong Cash Flows and Capital Returns
One of the important criteria to judge a company's financial health and the soundness of its business model is by looking at its cash flow. Disney generates billions of dollars in cash from operations. Disney's cash flow from operations has grown from $6.6B in 2010 to $10.9B in 2015. In the first nine months of 2016 Disney has already generated more than $9.3 billion in operating cashflows, an increase of 24% YoY.
And with the operationalization of the Shanghai park and upcoming movies, Disney's cashflows will continue to grow. All this will allow Disney to continue returning cash to shareholders without compromising on investing for the future. Disney reinvested around $3.7 billion in its business an increase of 20% from last year.
Disney has not been known for generous dividend payments, its current dividend yield stands at 1.4%. But Disney has been growing its dividend payments in last few years. The dividend has increased from $0.35 per share in 2010 to $1.81 in 2015, a CAGR of 31%. And with the strong free cashflows the company generating, dividend growth is likely to continue. Also, Disney has increasingly used the stock buyback route to return capital. In the last nine months, the company has bought back stock worth $5.9 billion, up from $2.8 billion dollars last year, which is more than 3.5% of the total float. This will not only provide confidence to shareholders but will also boost its EPS going forward (as number of shares will decline). Disney has achieved a double-digit EPS growth in the last twelve quarters.
In spite of posting a strong earnings result and 12th consecutive quarter of double-digit EPS growth, Disney stock has not done well. While all the segments have shown strong growth, the cord-cutting pressure on ESPN is an overhang. To counter the threat of cord-cutting, Disney has bought 33% stake in BAM Tech, with an option to buy the remaining stake. The growth potential of its studios and Shanghai business is huge. However, the Disney stock is trading 20% below its 52-week high at an attractive forward PE of 15.7. At the current valuation, Disney stock is a good buy, especially for long-term investors.