Lionsgate Entertainment (NYSE:LGF-A) (NYSE:LGF-B) has made a name for itself over the years by turning out midbudget movies that management calculates will likely turn a profit. The company is on a mission to grow into one of the largest movie studios in the world. Over the last decade, Lionsgate increased revenue by 160% to $3.8 billion. 

However, 2018 was not one of Lionsgate's best years. The stock tumbled 45% over the past year after the company reported disappointing operating results. Investors had high hopes for Lionsgate after the acquisition of Starz in fiscal 2017. The stock was sitting at a forward P/E of 28 in early 2018, reflecting high growth expectations, but the motion pictures segment (44% of fiscal 2018 revenue) had some misses at the box office last year that weighed on the company's profitability. Through the first three quarters of fiscal 2019, revenue was down 11%, which translated to a decrease in operating income of 26%. 

Meanwhile, Walt Disney (NYSE:DIS) is coming off a record year, in which its studios segment (17% of total revenue) posted a record $10 billion in revenue. Of course, Disney is not a better entertainment stock merely due to one year's performance relative to Lionsgate. However, Lionsgate's recent performance reveals a weakness in the company's strategy of spreading a wide net across midtier movies hoping that enough will turn a profit to keep the company growing.

Check out the latest earnings call transcript for Lionsgate.

A group of young women watching a movie in a theater.

Image source: Getty Images.

Two different strategies

Lionsgate releases about 20 or more movies each year. The company's 2018 release slate grossed $389 million at the box office -- the worst year for Lionsgate since 2011. Notable hits included A Simple Favor, starring Anna Kendrick and Blake Lively, and Overboard, starring Anna Faris. However, Hunter Killer and Robin Hood (2018) bombed, with both grossing a fraction of each movie's budget, according to data from Box Office Mojo. 

Lionsgate has had two years in the past decade with grosses of $1 billion or more. The average range of gross receipts per film at the box office is about $20 million to $40 million in most years.

Here is how Lionsgate's strategy has translated in terms of revenue and operating income over the last five years:

Metric TTM Through Fiscal Q3 2019 Fiscal 2018 Fiscal 2017 Fiscal 2016 Fiscal 2015 Fiscal 2014
Revenue $3.8 billion $4.1 billion $3.2 billion $2.3 billion $2.4 billion $2.6 billion
Operating income $212.4 million $249 million ($16 million) ($25 million) $222 million $260 million
Operating margin 5.6% 6% NM NM 9.3% 9.9%

Data source: Lionsgate. TTM = trailing 12 months. Lionsgate's fiscal year ends in March. NM = not meaningful.

On the other side, Disney typically releases no more than 10 movies every year, but that small slate packs its share of billion-dollar blockbusters. Revenue from the studios segment increased 36% between fiscal 2008 and fiscal 2018. It's no secret that Disney has an enormous advantage with its well-known brands and marketing muscle. Its acquisitions of Pixar, Lucasfilm, and Marvel Entertainment were game-changers for Disney in bolstering its studios segment with a deep library of content that should keep the studios segment well-stocked for decades.

Here is a look at the operating performance for Disney's studios segment over the last five years:

Metric TTM Through Fiscal Q1 2019 Fiscal 2018 Fiscal 2017 Fiscal 2016 Fiscal 2015 Fiscal 2014
Revenue $9.3 billion $9.9 billion $8.4 billion $9.4 billion $7.4 billion $7.3 billion
Operating income $2.4 billion $2.9 billion $2.4 billion $2.7 billion $1.9 billion $1.5 billion
Operating margin 26.5% 29.8% 28.1% 28.6% 26.8% 21.3%

Data source: Walt Disney. TTM = trailing 12 month. Disney's fiscal year ends in September.

What immediately jumps out is not only the consistency in generating a profit, but also the consistently high operating margin. Since Disney acquired Marvel in 2010 and Lucasfilm in 2012, the studios segment operating margin has improved from 10% in fiscal 2010 to 30% in fiscal 2018. There's no question Disney has what moviegoers want to see: sequels of popular franchises, especially comic book characters, that feature special effects and action sequences on an epic scale.

The problem for Lionsgate is that it can be very difficult for midbudget movies to stand out, particularly in light of the lower budget these films have for important things like marketing, which Disney is very good at.

Content pipeline

To be fair, Lionsgate isn't going anywhere. The company has a 16,000-title library to fuel its future film releases and television production. Disney's Marvel studios has a library of 7,000 comic book characters to drive future releases in the Marvel Cinematic Universe. 

But Disney has even more in the vault. The Star Wars universe has a library of 17,000 characters, and then there's the steady flow of story ideas coming from the talented filmmakers at Pixar. Disney could also make additional acquisitions in the future to expand its content library, similar to its recent deal to acquire Twenty-First Century Fox's entertainment properties. Disney's ability to go out and spend billions of dollars to buy another studio highlights the relative strength of Disney compared to Lionsgate.

Regardless, both companies have plenty in the pipeline. But one thing I would worry about with Lionsgate is its inconsistent operating history. You have to wonder if the company sometimes releases too many films and therefore stretches itself too thin, like last year.

Plus, there's also Lionsgate's debt burden of $2.97 billion, which is concerning. If the company was consistently turning out profits and delivering healthy margins, that would be one thing. But with Lionsgate's poor performance last year, it seems like the company has possibly been too aggressive at times with its growth strategy.

A more consistent entertainment stock

Disney's consistent stream of hits at the box office and the high operating margin the studios segment generates every year is impressive given that about half of movies don't make a profit. The company is not letting its foot off the gas: Another round of marquee films are releasing in 2019, with live-action remakes of classic Disney movies, including Dumbo, Aladdin, and The Lion King, in addition to Star Wars IX.

It will be tough for Disney's studios segment to beat last year's record year, particularly given the monster success of Black Panther (2018), which won three Oscars and was nominated for Best Picture. Regardless, investors can depend on Disney to crank out consistent profits from its film releases and continue to monetize those box office hits through feature attractions at its theme parks, consumer products, and subscriptions to the upcoming Disney+ streaming service.