Media and entertainment giant The Walt Disney Company (DIS) is going through a major transition under the leadership of its returned CEO, Robert A. Iger, after the company’s board decided to let go of Bob Chapek, Mr. Iger’s handpicked successor.

Having led the company for fifteen years, from 2005 to 2020, Mr. Iger has two years to find a successor all over again while steering the company on the right path in a pivotal period in the company’s 99-year history.

Mr. Iger has announced his commitment to plug the holes in DIS’s direct-to-consumer division, which he sees as the organization’s future, and return it to profitability during his time at the helm of affairs.

As expected, he has wasted no time in putting his turnaround plans in place. As a part of its overhauling strategy, on February 8, DIS announced its plans to cut 7,000 jobs and slash $5.5 billion in costs. This major corporate reorganization has been designed to give more power to the company’s content executives and put a greater emphasis on sports media.

While doing away with the Disney Media and Entertainment Distribution (DMED) segment that Mr. Chapek created, the company plans to organize its movie and television studios, linear television networks, and flagship streaming video services under a new division known as Disney Entertainment.

The rest of DIS’ businesses will be organized under the existing parks, experiences, and products division and the ESPN division. This would give content executives authority over how to market and distribute their titles and accountability for their segments’ financial performance.

Despite recovering 9.4% over the past month, the stock has lost 13.4% over the past six months and 28.6% over the past year to close the last trading session at $107.66.

Do the changes being implemented make DIS worthy of investment at this point?

Financial Performance Has Room for Improvement

For the first quarter of the fiscal year 2023, which ended December 31, 2023, despite a 7.8% year-over-year increase in revenue to $23.51 billion, DIS reported a total segment operating income of $3.04 billion, down 6.6% year-over-year.

The major cause behind this decline has been the poor performance of the now-disbanded Disney Media and Entertainment Distribution (DMED) division. Despite a 1% year-over-year gain in revenue, the segment registered an operating loss of $10 million compared to an operating income of $808 million during the previous-year quarter.

Despite being a priority for the management and essential to the organization’s long-term success, the direct-to-consumer (streaming) business registered an operating loss of $1.05 billion during the quarter, 77.6% worse year-over-year.

As a result of the above, DIS’ diluted EPS for the quarter, excluding certain items, decreased 6.6% year-over-year to $0.99. Its total current assets stood at $26.91 billion, as of December 31, 2022, compared to $29.10 billion as of October 1, 2022.

Poor Profitability

DIS’s trailing 12-month gross profit margin of 33.4% is 32.7% lower than the industry average of 49.65%. Similarly, the company’s trailing 12-month EBITDA margin of 14.1% is 27.6% lower than the industry average of 19.46%.

In terms of the trailing 12-month ROCE, ROTC, and ROTA, DIS also underperforms the industry averages of 3.62%, 3.70%, and 1.77% by 1.5%, 28.2%, and 7.2%, respectively.

Stretched Valuation

Despite the drawdown in its price, the stock is still trading at a premium compared to its peers. In terms of forward P/E, DIS is currently trading at 25.81x, 57.6% higher than the industry average of 16.37x. The stock’s forward EV/Sales multiple of 2.77 is 37.1% higher than the industry average of 2.02, while its forward EV/EBITDA multiple of 16.36 is 86.3% higher than the industry average of 8.79.

Also, the stock’s forward Price/Sales multiple of 2.19 compares with the industry average of 1.32.

POWR Ratings Reflect Weakness

DIS has an overall D rating, which equates to Sell in our proprietary POWR Ratings system. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight different categories. DIS also has grade D for Value and Quality, owing to its stretched valuation and lower profitability relative to its peers.

In addition, DIS has a grade D for Momentum, consistent with its bearish stock price action. It is ranked #12 of 15 stocks in the Entertainment – Media Producers industry.

Beyond what has been discussed above, additional ratings for Growth, Stability, Momentum, and Sentiment of DIS can be found here.

Questions Remain

While the restructuring plans and Mr. Iger’s assurance that he would seek approval from the board to reinstate a modest dividend by the end of this calendar year was enough to convince Trian Fund Management LP, led by Nelson Peltz, to call off its proxy fight against DIS, a few concerns remain unaddressed.

While DIS’s 2019 purchase of 21st Century Fox’s entertainment assets for $71.3 billion gives the company a bigger content library with more franchises, a broader global reach, and a crop of talented executives, it has also saddled the company with debt at a time when servicing it is getting progressively expensive amid rising interest rates.

Secondly, DIS is yet to communicate whether it intends to strengthen its operational control of HULU by acquiring the remaining 33% stake in the streaming services from Comcast Corporation (CMCSA) ahead of a 2024 deadline when either party could force a sale.

Thirdly, since 2019, when Disney+ was launched, the segment has lost nearly $10 billion, as the company has spent heavily on content to attract subscribers. A recent price hike for DIS’ streaming services likely led to the loss of around 2.4 million Disney+ subscribers during the quarter due to the loss of subscribers in India and other Asian countries, where DIS lost streaming rights to cricket’s Indian Premier League.

While DIS would focus more intently on its core franchises, its plans to trim its spending on content marketing and review the prices of subscription packages may backfire amid increased competition and decreasing discretionary expenditure with a looming economic slowdown.

Last but not least, DIS’s differences with Gov. DeSantis culminated with the Florida Senate approving the Disney Special Tax-District Bill, which would seek to move the control of the Reedy Creek district from the company back to the state.

Disney Parks, Experiences, and Products division was the highlight of the company’s recent earnings, with revenue increasing 20.8% year-over-year to $8.74 billion and operating income increasing 24.6% year-over-year to $3.05 billion.

Since enacting the above legislation would end DIS’s exemption from state regulatory reviews and approvals that other companies must go through, it might become a major headwind for the segment. 

Bottom Line

Analysts expect the company’s EPS for the fiscal second quarter to decrease 7.4% year-over-year to $1.00.

Hence in view of the above, despite DIS’s size, history, and global appeal, its near-term prospects seem uncertain.

In addition, given its poor profit margins and high valuation, we believe it would be wise to avoid the stock now.

How does The Walt Disney Company (DIS) Stack up Against Its Peers?

DIS has an overall POWR Rating of D, which equates to a Sell rating. Therefore, you might consider looking at its industry peer, AMC Networks Inc. (AMCX), which has a B (Buy) rating.

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DIS shares were trading at $107.49 per share on Tuesday afternoon, down $0.17 (-0.16%). Year-to-date, DIS has gained 23.72%, versus a 7.35% rise in the benchmark S&P 500 index during the same period.

About the Author: Santanu Roy

Having been fascinated by the traditional and evolving factors that affect investment decisions, Santanu decided to pursue a career as an investment analyst. Prior to his switch to investment research, he was a process associate at Cognizant. With a master's degree in business administration and a fundamental approach to analyzing businesses, he aims to help retail investors identify the best long-term investment opportunities. More...

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