The Walt Disney Company (DIS, Financial), a global entertainment giant, came under pressure in March as the United States and many other countries around the world shut down large gathering areas like theme parks, cruise operations and theatres in order to slow the spread of the Covid-19 pandemic.
At the market price of around $119 on July 15, the stock is down 19% this year. The negative sentiment toward the company in the market is justifiable as earnings are expected to take a massive hit through the end of 2020. Even though the outlook seems bleak, though, a few analysts are seeing Disney as a deep value play.
The latest developments
In May, the company decided to reopen the Shanghai Disneyland with reduced capacity, and the tickets were sold out within a few hours from being made available to parkgoers. Even though the stock price recovered with this development, some believed that this would not add meaningful revenue to the company as the Chinese government imposed a maximum operating capacity of 30%. Improving the sentiment of investors, Disney reopened its theme park in Hong Kong last month, only to be forced to walk back that decision on July 13 due to the increasing number of new Covid-19 cases in the city.
There is, however, some positive news for investors regarding its operations in the United States. Even as many states in the country are getting ready for the second phase of a lockdown, Disney has decided to go ahead with its plan to reopen theme parks in key locations. Last Saturday, Magic Kingdom and Animal Kingdom in Orlando, Florida were opened to the public, and the company is so far impressed with the response from the public to adhere to safety measures. Commenting on the early success, Disney’s Parks, Experiences and Products segment Chairman Josh D’Amaro said:
“There’s a lot of trust here, both from our cast members and our guests, and we’ve got a responsibility to deliver on that trust. Guests have so far been very cooperative with new safety measures like temperature checks and face coverings.”
The success of the Parks segment is an important contributor to company revenue and earnings, which is sometimes overlooked by investors. Below is an illustration of segmental contribution to revenue in 2019.
Source: Company filings
The partial reopening of parks around the world will not only improve the numbers, but also the sentiment of investors toward the entertainment giant. This is one of the primary reasons behind the positive outlook painted by some Wall Street analysts in the past couple of days. JPMorgan analyst Alexia Quadrani wrote:
“The Reopening of the parks globally is a critical sign of recovery as this removes the largest overhang at the company due to Covid-19.” He continued, “There is an increasing conviction that the health of the company is returning throughout several of its segments, with a move toward profitability in fiscal 2023 at Disney+, the reopening of the parks, and the return of live sports.”
Investors, however, need to factor in the possibility of all reopened parks being forced to close down once again in the future, which is the most apparent risk of investing in Disney at this point.
Disney+ could be a gamechanger
Since its launch last November, the subscription-based content streaming platform Disney+ has gained traction at a record pace. On April 8, the platform achieved a key milestone by surpassing 50 million global subscribers. To add some perspective, it took Netflix, Inc. (NFLX, Financial) seven years to achieve this feat. One of the key pillars of this early success is its strong footing in India where its competitors have failed to gain momentum.
According to data from Forbes, Hotstar controls 29% of the market share in India whereas Netflix is a much smaller player serving just 5% of the total market. Hotstar is owned by Novi Digital Management, which is a subsidiary of Walt Disney, and the company has leveraged this relationship to launch the new platform in collaboration with the leading video streaming provider in the country. As a result, Disney+ reported 13 million new Indian subscribers in just a few days from launching the service, whereas Netflix still has only 2 million paying users after serving this market for many years. Disney is thus likely to grow faster in this important region, which could add revenue by 2021.
The deep content library owned by Disney and the emotional attachment with its brand and characters is another strength of the company that could drive new subscriptions at a stellar rate.
The rising debt problem
Disney carried long-term debt of over $42 billion at the end of the first quarter and total debt close to $60 billion. To remain solvent during this economic downturn, the company issued $11 billion more in debt in May. Even though this would help Disney navigate the current situation better due to the improved liquidity, the indebtedness might come back to hurt investors in the future. The newly raised debt and the cash balance of over $14 billion as of March 31 will be sufficient for the company to manage the difficult conditions at least until the end of this year, but Disney will be forced to depend on more borrowing if its business operations do not improve by 2021.
Takeaway
Investing in Disney amid this challenging macro-economic environment is a contrarian play, and not every investor is convinced about the story. Some analysts, however, believe the company will reward investors handsomely in the long run once the recession fears subside and the global economy gets back on track. Bank of America Merrill Lynch analyst Jessica Reif Ehrlich reiterated her target price of $146 on July 8 and wrote:
“Although Covid-19 pressures should continue to weigh on near-term financials, we believe Disney is positioned to grow stronger through the crisis (e.g., a faster Disney+ rollout, better long-term theme park margin potential and improved ESPN programming appeal) and numerous catalysts exist to drive growth higher.”
In the most likely scenario, I predict the company will take a massive hit to earnings this year but will recover by mid-2021 along with the expected growth in the global economy. On the other hand, pent-up demand will help Disney secure revenue from its Parks segment. The company’s efforts to digitize its services by introducing Disney+ and launching new movies online will be a positive trend for the long-term success of the company, considering the pace at which the world is digitizing.
Disclosure: I do not own any shares mentioned in this article.
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