Disney Valuation, Part 1: Parks and Studio

The first article in a series on The Walt Disney Company

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I recently wrote an article about Disney's (DIS) transition towards a direct to consumer (DTC) model, most notably as it related to structural change in the Media Networks segment. The point I made was that this transition, which began a few years ago, is still in its early innings.

This article, the first in a series of five articles, will answer a different question: are Disney shares attractive for long-term investors at current levels? Full disclosure, I hold a sizable position in Disney. I'll do my best to be unbiased, but you should take that fact into consideration.

Let's start by looking at Disney's businesses outside of the Media Networks (within which I'll include DTC & International). What we're left with is the Parks, Experiences and Products business, as well as the company's Studio Entertainment business.

At Parks, Experiences and Products, Disney has been firing on all cylinders. In 2019, the segment reported $6.8 billion in operating income, an increase of 65% compared to the $4.1 billion in operating income generated five years earlier. As shown below, this reflects an impressive decade for the business.


But after many years of growth in theme park attendance and per capita spending, along with strong results for consumer products due to the company's growing and unparalleled collection of brands, Disney is now facing significant headwinds as a result of the pandemic. The domestic theme parks have been closed for a month, and they're unlikely to reopen any time soon. At the time of writing, all of the company's international parks remain closed as well.

A year ago, the segment generated $19 million in operating income a day, without adjusting for seasonality, with 70% from parks and experiences (see page 41 of the 2019 annual report). Now, it's probably safe to assume that parks and experiences is losing a good amount of money. When the parks will ultimately reopen is anybody's guess. Just as important, in my opinion, is the impact this may have on the business going forward. As we return to some sense of normalcy, will people be comfortable crowding into places like theme parks with tens of thousands of other guests as they used to? Maybe the answer is yes, but I wouldn't be surprised if that takes time. Even when the fight against the virus is "finished," its impact on our collective behavior may remain.

I also think it's worth noting that the U.S. economy has done fairly well in recent years. It seems fair to say we've been running near full throttle, which has been a nice tailwind for Disney's Parks, Experiences and Products segment. Naturally, that can only continue for so long. To put some numbers on it, consider that segment margins in fiscal 2019 were 26% - roughly 600 basis points higher than the trailing ten-year average. That undoubtedly reflects other factors as well (like more effective pricing strategies), but a strong economy helps. The point is that segment earnings in 2019 may have been higher than what one should reasonably expect across an economic cycle.

Finally, segment depreciation and amortization expense in 2019 was $2.3 billion compared to capital expenditures of $4.1 billion. (Note that more than 75% of Disney's capital expenditures in recent years have been incurred in the Parks and Experiences segment.) Admittedly, much of that spend is for growth, not maintenance. These investments, such as Star Wars: Galaxy's Edge, improve the park experience and have helped Disney to increase park capacity and charge higher prices.


As we think about the segment's normalized earnings power, I think it's safe to assume that we will continue to see a large gap between depreciation expense and capital expenditures at Disney. Looking solely at operating income as opposed to segment cash flows overstates the results.

Now let's look at the Studio Entertainment division. As former CEO Bob Iger noted on the company's most recent quarterly conference call, 2019 was a stellar year for Disney's movie business:

"The Rise of Skywalker and Frozen 2, along with Captain Marvel, Aladdin, The Lion King, Toy Story 4 and the biggest movie of all time, Avengers: Endgame, contributed to a global box office of more than $11 billion, shattering the previous industry record of $7.6 billion set by us in 2016."

In 2019, Studio Entertainment revenues increased 11% to $11.1 billion, led by theatrical and TV / SVOD distribution (licensing). Over the past five years, despite lower Home Entertainment sales, segment revenues increased at a 9% compounded annual growth rate (CAGR). As shown below, segment profitability has also improved meaningfully over the past few years.


I want to call out 2019 operating income, which was lower than 2018 due to the difference between the calendar year and Disney's fiscal year, as well as the inclusion of 21st Century Fox studio, which reported a loss of a few hundred million dollars for the year. Here's the bigger picture: over the past five years (fiscal 2015 to fiscal 2019), the Studio business has generated $2.5 billion in operating income per year, on average, compared to $850 million a year from fiscal 2010 to fiscal 2014. After the best year for any company in the industry's history (by a wide margin), Disney is unlikely to come anywhere close to that outcome in 2020. That is particularly true after accounting for the impact of COVID-19, which has closed thousands of movie theaters in many countries around the world.


Disney's results in the Studio Entertainment segment and in the Parks, Experiences and Products segment were strong in 2019, just as they have been in recent years. While that reflects the impact of continued investment, I also think it was at least partly attributable to fortuitous timing and where we were at in the economic cycle. Put differently, it's my belief that these businesses may have earned more in 2019 than what you should reasonably expect in an average year.

For that reason, as we think about valuing these segments, I'm going to discount their 2019 results. Collectively, they reported operating earnings of $9.5 billion last year. As shown below, I've set a pretty wide range to discount those results (the yellow boxes include a range from a 10% discount to a 25% discount). In addition, I've accounted for taxes (at a 21% effective tax rate). Finally, I've applied a range of multiples from 13 times to 28 times trailing earnings. Here's the output.


I've highlighted the assumptions that I find most reasonable. Based on the financials, I think you can make the case that these business segments are collectively worth $90 billion to $170 billion.

My next article on this topic will examine the other business segments at Disney.

Disclosure: Long DIS

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