The Walt Disney Company (NYSE: DIS) had a tough year amid some headline-grabbing controversies in addition to macroeconomic headwinds with stocks down more than 40% from their 2021 peak. next week, we reaffirm a bullish call on the stock and expect the next big move to be higher. Strong reports guest levels at Disney’s theme parks as well as the continued momentum of streaming services may open the door to a beat in earnings. The possibility that Disney could dismiss fears of a slowdown in consumer spending and broader economic weakness could be enough to spark another rally in the stock. In our view, the opportunity here is to select a high-quality market leader at a lower price point that maintains a positive long-term outlook.
Why did DIS shares fall
The company last reported second-quarter earnings in May with revenue of $19.2 billion, up 29% year-over-year, which also marked a milestone important, exceeding its pre-pandemic benchmark of the second quarter of 2019.
On the other hand, EPS of $1.19, although up 37% compared to the period last year, was still 32% lower than the result of 3 years ago, highlighting the depressed earnings environment. In this case, the problem has been the heavy investments in Disney’s direct-to-consumer streaming services, including Disney+ and ESPN+.
Operating income from the Media and Entertainment Distribution segment fell this year, preventing Disney from enjoying even stronger profitability. Compared to significant optimism for subscriber growth targets in 2021, results from peers like Netflix, Inc. (NFLX) which lost members, helped dampen expectations about Disney’s streaming potential.
All this in a more challenging macro environment. Record inflation, rising interest rates and worries about global growth have weighed on Disney, fearing a hit to consumer spending could put pressure on its operating momentum. This will be a key theme to watch in the next quarterly report, as we feel Disney could buck the trend yet again.
Finally, we discussed the Disney controversy this year. A few months ago, the company came under fire for its response to Florida’s “parental rights in education” legislation, seen by opponents as a violation of free speech and equal protection rights for the LGBTQ community. One side of the discussion felt the company hadn’t done enough to block the measure, while supporters of the bill believed Disney had gone too far in wading into a political topic.
That being said, beyond the internet firestorm with calls to boycott Disney products, there is no indication that the issue has had a significant financial impact on the company. What we can say is that this explains some of the bad sentiment towards the stock as an added layer of volatility.
Overview of DIS Q3 results
Disney has a chance next week to set the record straight in what we consider a critical earnings report scheduled for August 10 after market close. The current consensus calls for EPS of $0.99, which if confirmed represents a 24% increase over the period last year. Forecast revenue of $21.0 billion, up 23% year-on-year, would break a quarterly record for the company, driven largely by streaming growth.
We see several reasons to expect a lot of higher and lower results with room for Disney to exceed expectations. First, there is every indication that the company’s core parks and resorts business has been otherwise immune to any economic downturn. Disney-focused trade publications ran year-round reports of parks crowded and regularly sold out through the required reservation system. This includes properties not only in Florida, but also at Disneyland in California and even Disneyland Paris.
The theme here relates to strong overall demand for leisure and travel on the back of pent-up demand post-pandemic. Another dynamic at play is the aggressive pricing actions on Disney’s part between not just daily admission tickets and annual passes, but also everything from food and drink to hotel room rates. Again, trends suggest that consumers are willing to pay for the Disney experience without lacking demand.
The impact here translates directly into higher margins for the operating segment. This has already been confirmed in the company’s latest quarterly report, but we expect this third quarter to capture the bulk of the summer travel season. For context, Q2 Parks, Experiences and Products segment operating income of $1.8 billion with a 26% margin, was up from $1.5 billion and a margin of 24% in Q2 2019, the year before the pandemic. In other words, the parks business is already more profitable than ever, which helps to balance investments towards streaming.
Again, the biggest question mark and where most eyes will be focused are the results from the media and entertainment distribution group which includes streaming services. On that count, Disney is still capturing solid growth with Disney+ adding 7.1 million subscribers over the past year in the U.S. and Canada to 44.4 million, or 1.5 million just since the start. first trimester. International momentum is also strong, with 43.2 million subscribers, up 39% y/y.
Disney+’s appeal over the host of alternative streaming platforms lies in the strength of its legacy catalog and blockbuster properties, including “Marvel” and classic animations. Star Wars Originals like “The Book of Boba Fett” and “Obi-Wan Kenobi,” which have become the most-watched series on Disney+, likely worked to keep subscribers engaged and can sustain a strong result this quarter.
More impressive has been ESPN+’s momentum, with subscriber numbers rising 62% over the past year to 22.3 million. The company recently announced an increase in the monthly subscription rate from $6.99 to $9.99. The impact here is significant given that the additional $3.00 per subscriber per month translates to over $800 million in additional annual revenue. Although nothing has been announced yet, investors can also expect a possible hike in the price of monthly subscriptions to Disney+, which compared to Netflix or even Amazon.com, Inc.’s “Amazon Prime” (AMZN ), seems like a bargain at the current US monthly rate of $7.99.
Along with this revenue report, management updates on major movie releases this year, including “Thor: Love and Thunder” currently in theaters, as well as “Black Panther: Wakanda Forever” and “Avatar 2” slated for later this year highlight the number of party moves that keep Disney interesting.
DIS Stock Price Prediction
Overall, we feel the market is underestimating Disney’s growth and the underlying trend of tighter margins. What we find is that management pricing actions across all segments are a powerful tool that can increase profitability.
A particularly strong result in the Parks and Experiences segment’s third-quarter report could be enough to beat earnings next week, pushing stocks higher. Favorably, the stock price action has turned more positive in recent weeks, with the DIS up almost 20% from its recent low. On the upside, a break above ~$112.50 may put the bulls back in control for another sustained rally.
Ultimately, the bullish scenario for Disney is that as earnings beat expectations, upward revisions to long-term EPS estimates will make stocks look increasingly cheap. The consensus is that from an EPS forecast of $3.93 for this fiscal year, earnings are expected to climb to $5.41 in 2023 and $6.39 by 2024.
Part of that momentum sees next year enjoying a full period of normalized post-pandemic operations while 2022 got off to a slower start. In our view, DIS trading at a 1-year PER of 20x is compelling for this earnings growth momentum.
Our call here is for a strong Q3 report from Disney paving the way for a sustained rally for the rest of the year. A break above $110 can set the stage for a move towards $130 as an upside target over the next few months. The watch points will be segment operating margins and streaming subscriber trends. We would like management to tell us that demand levels at its parks remain at record highs.
When it comes to risk, consider that general market conditions remain volatile. A deterioration in global economic conditions from the current baseline towards a deeper recession would undermine the earnings outlook. That said, as long as consumer spending levels remain relatively stable and inflation rates start to decline, we maintain a more optimistic view. The continued decline in gas prices should be positive for consumer confidence over the next few months and provide favorable winds for the economy as a whole.