Home Deep Analysis Disney: Superior Economic Moat, Strong Cash Generation (NYSE: DIS)

Disney: Superior Economic Moat, Strong Cash Generation (NYSE: DIS)

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Disney: Superior Economic Moat, Strong Cash Generation (NYSE: DIS)


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investment thesis

The Walt Disney Company (NYSE: DIS) is a diversified global entertainment company with movie franchises, streaming services, theme parks and merchandising.Since the creation of Mickey Mouse in the 1920s, Disney has achieved great success, acquiring and expanded into many different businesses. Shares of Disney have plummeted since mid-2021 and are now at half their previous levels due to broader market volatility, the collapse of Netflix and woes across the entertainment and hospitality industries. I believe the market is overly underestimating Disney’s strength and I expect Disney to recover because:

The parks and entertainment business is recovering, and Disney can’t actually meet full demand due to labor shortages. Disney has strong cash-generating capabilities and a solid balance sheet. Their debt-to-equity ratio (50%) is much higher than rivals Netflix (99%) and Warner Bros. (106%). Streaming services are reaching their peak, and movie theaters are getting busier. Earnings over the past twelve months have surpassed pre-pandemic levels.

Resume theme park and entertainment business

Parks and recreation businesses are recovering and thriving. According to the latest filing, the Disney Parks, Experiences and Products segment more than doubled compared to last year. Management mentioned that this strong performance was due to increased demand and enhanced personalized customer experience. Compared with pre-pandemic levels in 2019, per capita spending has increased by more than 40%.

I expect the Parks and Recreation business to continue to perform strongly as passenger numbers pick up, new rides (eg, Next Generation Storytelling and Guardians of the Galaxy), and theme park expansion (eg, Disneyland Paris). Additionally, Disney theme parks’ current capacity is limited by labor shortages, not demand. Demand is actually very strong. Disney is doing everything it can to recruit employees, including offering bigger signing bonuses, and their headcount is rising. Revenues will grow as positions fill and Disney should be able to meet the full needs of customers.

Disney Financial Statements

financial report (SEC filing)

Disney employee number

Disney employee number (macro trend)

Strong financial position and economic moat

One of the main benefits of investing in a blue-chip company like Disney is their strong financial position and clear economic moat. Even during the pandemic, Disney generated operating cash flow of $3.7B in 2020 and $3.5B in 2021. Not surprisingly, their balance sheets are much stronger than their competitors. Their total debt-to-equity ratio (50%) is almost half that of Netflix (99%) and Warner Bros. (106%). With the Fed determined to rein in inflation, this strong financial position should give investors peace of mind even in the face of a recession.

Additionally, Disney has a very clear economic moat. Disney owns brands like Marvel, ESPN, National Geographic, Lucasfilm and Pixar. To sum up, this forms a composite market leader group, forming a strong economic moat. A downturn in the economy may temporarily affect movie or theme park revenues, but only in the short term. In the long run, consumers will return to Disney’s movies, parks and merchandise.

Disney owned company

Disney owned company (largest title)

Strong streaming and movie market

Disney’s streaming services and movie businesses are also growing. Disney ended the second quarter with more than 205 million total subscriptions, and they expect to reach 230 million to 260 million Disney+ subscribers by 2024. Their expansion plans include 1) going international, 2) low-cost ad-supported subscriptions, and 3) capitalizing on blockbuster titles like Star Wars: The Book of Boba Fett and Marvel’s Moon Knight. Given their long history of success in the film and broadcast industries, I have no doubt they will achieve their goals.

The movie market is also recovering. The number of ticket sales has been rising sharply since the middle of the 2020 pandemic. That number may not have fully recovered to pre-pandemic levels, but it is certainly trending upward. Ticket sales in the U.S. and Canada in June were about $990 million, only about 10% lower than in 2019. Given that movie attendance (compared to 2019) was down 44% in April and 26% in May, that’s a massive uptick. As we move out of the pandemic, I expect box office numbers to return to the pandemic soon previous level.

US annual pass sales

US annual pass sales (Number)

Intrinsic value estimate

I use a DCF model to estimate Disney’s intrinsic value. For the estimate, I use free cash flow ($10.8 B) and the current 8.0% WACC as the discount rate. For the base case, I assume 14% cash flow growth over the next 5 years (seeking Alpha estimates) and zero growth thereafter (zero terminal growth). For the bullish and very bullish scenarios, I assume cash flow growth of 17% and 20% over the next 5 years, and zero growth thereafter. Growth of 17-20% seems achievable given their continued recovery in their theme park and movie businesses.

Estimates show that the current share price has room for upside of 15-30%. Given their economic moat, recovery in their theme park and movie businesses, and increased streaming revenue, I expect Disney to continue to recover and eventually deliver this growth.

price target

Upside

basic situation

$108.72

13%

bullish case

$121.67

27%

very bullish case

$135.93

42%

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

WACC: 8.0% Cash Flow Growth: 14% (Base Case), 17% (Bull Case), 20% (Very Bullish Case) Current EBITDA: $10.8B Current Share Price: $95.86 (July 8, 2022) Tax Rates : 20%

Cappuccino Stock Ratings

Weighted DIS Economic Moat Strength 30% 5 Financial Strength 30% 4 Growth Rate and Industry 15% 3 Margin of Safety 15% 5 Industry Outlook 10% 4 Overall 4.3

Economic Moat Strength (5/5)

Disney has one of the strongest economic moats. Their iconic characters and brands are part of everyday pop culture. It’s impressive how many different parts of their business (animated films, sports, streaming, TV broadcasting, etc.) have been able to generate a lot of cash even during the pandemic.

Financial Strength (4/5)

Disney has been a money-making machine for the past few decades. Even with their theme park business semi-crippled during the pandemic, they were able to generate over $3B in operating cash flow. Their balance sheets are much stronger than their competitors.

Growth rate (3/5)

Disney’s growth rate over the next few years will be excellent as we emerge from pandemic restrictions and return to pre-pandemic activities. However, the long-term growth rate should stabilize at around 5-7% per annum, which will be in line with the rest of the industry and competitors.

Margin of Safety (5/5)

The recent share price decline (about 40%) provides investors with a great opportunity to buy Disney stock at a discount. A blue-chip company with a strong economic moat like Disney is a great way to build long-term wealth, if you can grab it on the cheap.

Industry Outlook (4/5)

The entertainment industry will grow with the population and the economy. A portion of people’s disposable income naturally goes to entertainment. As a leader in the entertainment business, Disney will enjoy long-term industry growth.

risk

The Fed appears determined to fight inflation through recession. Whenever the stock market gains some momentum, the Fed throws cold water on it by raising interest rates dramatically or predicting dire economic conditions. As such, I don’t expect stocks to gain any sustained momentum until inflation falls. During a recession, theme park attendance will naturally drop and movie theaters will spend less, hurting Disney’s growth prospects.

Disney is approaching a 2024 deadline to buy another 33% stake in Hulu ($27.5 B). Incorporating Hulu into Disney could constrain capital, drain human resources and create conflicts in merging two different business models. Since Disney already has a successful Disney+ streaming service, Hulu’s value to Disney has dropped significantly over the past few years. Disney certainly has a lot of experience acquiring and integrating new businesses, so I hope they’ll find a way to successfully leverage Hulu’s content and user base. However, investors should keep an eye on progress.

in conclusion

Disney has been an excellent investment over the past few decades. With many market-leading brands and characters, I expect them to remain cash-producing machines for the long haul. A resurgent theme park and movie business should lead to growth spurts followed by steady long-term growth. A potential recession is just a temporary setback. Overall, I expect 15-30% upside.

market preparation

Thank you all for reading my article. I’m getting ready for the upcoming Marketplace. Please get excited! Also, let me know what type of analysis or information you would like to see in my article. I’ll take that into account in the market. thanks for your support!

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