Disney: Outstanding Economic Moat, Strong Cash Generating Capability (NYSE:DIS)

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investment work

The Walt Disney Company (NYSE:DIS) is a diversified global entertainment company with film franchises, a streaming service, a theme park and merchandising. Since the creation of Mickey Mouse in the 1920s, Disney has experienced tremendous buyout success and expand into many different businesses. Disney’s stock price has plummeted since mid-2021 and is now at half its previous levels due to broader market volatility, Netflix’s collapse, and struggles in the entertainment and hospitality industries. I believe the market is overestimating Disney’s strength and I expect Disney to recover because:

  • The park and entertainment businesses are recovering, and indeed Disney is unable to meet full demand due to labor shortages.
  • Disney has strong cash-generating ability and a solid balance sheet. Its leverage (50%) is much stronger than its peers Netflix (99%) and Warner Brothers (106%).
  • The streaming service is at its peak and the cinemas are getting full. Revenues for the past 12 months have already exceeded pre-pandemic levels.

Revival of the amusement park and entertainment business

The park and entertainment business is recovering and booming. Based on the most recent filing, the Disney Parks, Experiences and Products segment more than doubled compared to last year. Management mentioned that this strong performance was due to increasing demand and improving the personal guest experience. Spending per capita increased by more than 40% in 2019 compared to pre-pandemic levels.

With passenger numbers recovering, new rides (e.g., Next Gen Storytelling and Guardians of the Galaxy), and theme park expansions (e.g., Disneyland Paris), I expect the parks and entertainment business to continue its strong performance. Also, the current capacity of Disney’s theme parks was limited by labor shortages, not demand. The demand is actually very strong. Disney is doing everything it can to fill positions, including offering bigger signing bonuses, and staff numbers are increasing. If the positions are filled, Disney should be able to meet full customer demand and sales will increase.

Disney financial report

annual accounts (SEC filing)

Disney Employee Counts

Disney Employee Counts (macro trends)

Strong financial position and economic moat

One of the key benefits of investing in a blue-chip company like Disney is its strong financial position and well-defined economic moat. Even in the midst of the pandemic, Disney generated $3.7 billion and $3.5 billion in operating cash flow in 2020 and 2021, respectively. Unsurprisingly, their balance sheet is much stronger than that of their peers. Their total leverage (50%) is nearly half that of Netflix (99%) and Warner Brothers (106%). With the Federal Reserve determined to control inflation even in the face of a recession, this strong financial position should provide investors with reassurance.

Also, Disney has a very well-defined economic moat. Disney owns brands like Marvel, ESPN, National Geographic, Lucasfilm and Pixar. All in all, this forms a composite group of market-leading figures and creates an impressive economic moat. A recession may have a temporary impact on movie or theme park revenue, but this is only a short-term impact. Consumers will return to Disney’s movies, parks, and merchandise in the long run.

Companies Disney owns

Companies Disney owns (Title Max)

Strong streaming and film market

Disney’s streaming services and movie business are also growing. Disney ended the second quarter with more than 205 million total subscriptions and expects to reach 230 million to 260 million Disney+ subscribers by 2024. Their expansion plan includes 1) growing into international markets, 2) ad-supported, lower-cost subscriptions, 3) leveraging blockbuster titles like Star Wars: The Book of Boba Fett and Marvel’s Moon Knight. Given their long track record in film and broadcast, I have little doubt that they will achieve their goals.

The film market is also recovering. Ticket sales have surged since the mid-pandemic in 2020. While the number has not fully recovered to pre-pandemic levels, it is definitely on an upward trend. Ticket sales for June in the US and Canada were approximately $990 million, down only about 10% from 2019. This is a sharp increase considering that April’s admissions (compared to 2019) down 44 % and down 26 % in May . As we move out of the pandemic, I expect box office numbers will soon return to pre-pandemic levels.

Annual pass sales in the USA

Annual pass sales in the USA (The payment)

Estimation of the intrinsic value

I used a DCF model to estimate Disney’s intrinsic value. For the estimate, I used free cash flow ($10.8 billion) and the current WACC of 8.0% as the discount rate. For the base case, I have assumed 14% cash flow growth (Seeking Alpha estimate) for the next 5 years and zero terminal growth thereafter. For the bullish and very bullish cases, I have assumed cash flow growth of 17% and 20% respectively for the next 5 years and no growth thereafter. Given that their theme park and movie businesses continue to recover, 17%-20% growth seems achievable.

The estimate showed that the current share price has upside potential of 15-30%. Given their economic moat, the recovering theme park and movie industries, and rising streaming revenue, I expect Disney will continue to recover and eventually meet that upside potential.

price target

On the top

base case

$108.72

13%

bullish case

$121.67

27%

Very bullish case

$135.93

42%

The assumptions and data used for the price target estimate are summarized below:

  • WACC: 8.0%
  • Cash flow growth rate: 14% (base case), 17% (bullish case), 20% (very bullish case)
  • Current EBITDA: $10.8 billion
  • Current share price: $95.86 (07/08/2022)
  • Tax rate: 20%

Cappuccino Stock Rating

weighting DIS
Economic moat strength 30% 5
financial strength 30% 4
Growth Rate vs. Industry fifteen% 3
margin of safety fifteen% 5
Industry Outlook 10% 4
In total 4.3

Economic moat strength (5/5)

Disney has one of the deepest economic rifts ever. Their iconic characters and brands are part of everyday pop culture. It’s also very impressive that many different areas of their business (animated film, sports, streaming, TV broadcasting, etc.) have been able to generate tons of money even in the midst of a pandemic.

Financial strength (4/5)

Disney has been a moneymaker for the past several decades. Even in the midst of the pandemic and with their theme park business semi-paralyzed, they were able to generate over $3 billion in operating cash flow. Their record is much stronger than that of their competitors.

Growth rate (3/5)

Disney’s growth rate will be stellar over the next few years as we exit pandemic restrictions and recover to pre-pandemic activity. However, the long-term growth rate should stabilize in the range of around 5-7% per year, which will be in line with the rest of the industry and its competitors.

Safety Margin (5/5)

The recent fall in the share price (~40%) has provided investors with a great opportunity to buy Disney shares at a discount. A blue chip company like Disney with a strong economic moat is a great way to build long-term wealth if you can snag it at a bargain price.

Industry Outlook (4/5)

The entertainment business will grow with the population and the economy. Of course, some of people’s disposable income will go to the entertainment business. As the leader in entertainment, Disney will enjoy the long-term growth of the sector.

risk

The Federal Reserve appears determined to trigger a recession to fight inflation. Every time the stock market picks up some steam, the Federal Reserve comes out and throws cold water on them, either raising interest rates sharply or forecasting a bleak economic scenario. As such, I don’t expect the stock market to gain sustained momentum until inflation comes down. Of course, in a recession, there will be fewer theme park visits and less box office spending, and that will hurt Disney’s growth prospects.

Disney is nearing a 2024 deadline to buy an additional 33% stake in Hulu ($27.5 billion). Incorporating Hulu into Disney could constrain capital, drain human resources, and create conflicts in bringing two disparate business models together. Because Disney already has a successful Disney+ streaming service, Hulu’s value to Disney has declined sharply in recent years. Disney certainly has a lot of experience acquiring and onboarding new companies, so I expect they’ll find an approach to successfully leverage Hulu’s content and subscriber base. However, investors should keep a close eye on the progress.

Conclusion

Disney has been an excellent investment over the past few decades. With many of the market-leading brands and characters, I expect to remain a moneymaker for a long time to come. The recovering amusement park and movie businesses should provide a boost in growth, followed by steady long-term growth. A possible recession would only be a temporary setback. Overall, I expect 15-30% upside potential.

Marketplace in preparation

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About Gloria Skelton

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