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Disney: Buy the Dip?

By Will Healy – Updated May 12, 2020 at 4:09PM

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The entertainment giant should regain revenue as the world gradually reopens.

Amid the COVID-19 crisis, Walt Disney (DIS -2.60%) has seen massive declines. The pandemic has shut down several of Disney's businesses and led to plummeting revenue and profits. While that may not hurt the company as much as the financials indicate, it is little wonder that Disney stock has fallen more than 25% year to date.

However, despite a bleak outlook, some parts of Disney have prospered during this crisis. Moreover, as conditions slowly return to normal, both Disney and its stock should be positioned to recover.

The effects of the coronavirus

The pandemic has forced Disney to close several of its theme parks, leave its cruise ships in port, and halt film and television production. Additionally, with virtually all sports on hiatus, ESPN has no new games to broadcast, which has dramatically lowered the network's viewership.

Given these conditions, the financials from the recent quarter should not come as a surprise. Since the coronavirus did not begin to impact the company until late in the quarter, revenue still increased 21% year over year. However, GAAP earnings fell an astounding 93%. Although free cash flow remained positive, it also fell 30% to $1.9 billion.

Two teenage girls enjoying a roller coaster ride.

Image source: Getty Images

Those dramatic declines led Disney to suspend its dividend. Skipping its next semi-annual payout, which previously had amounted to $0.88 per share, will save the company $1.6 billion. The company has also furloughed employees from its theme parks, reduced capital expenditures, and borrowed more money to bolster its cash position.

Disney will likely need that cash -- the analysts' consensus is that the company will lose $0.78 per share in the current quarter (ending in June).

Signs of optimism

Still, Disney bulls can point to one area where it's prospering right now -- streaming services.  Thanks to Disney+, Hulu, and ESPN+, revenue in the direct-to-consumer international division increased from $1.1 billion to $4.1 billion year over year in the latest quarter. Disney+ has already reached 54.5 million subscribers as of early May, while ESPN+ more than tripled its subscriber base to 7.9 million.

Another bright spot is Shanghai Disneyland, which reopened Monday, though only at 30% capacity. While we do not yet know when its other theme parks, cruises, or stores will resume operations, the move represents a turning point for Disney's parks, experiences, and products division.

Additionally, we have witnessed the beginning of the return of live sports. ESPN now broadcasts Korean baseball, which is being played without fans in the stadium. While the timing on resuming U.S. and European competitions remains unclear, the KBO League is pioneering a path that could lead to the return of other live sporting events in the near future.

Where Disney stock stands

Even before the pandemic-induced sell-off began, Disney's performance was lagging the S&P 500 in 2020. Moreover, while the broad market has regained the majority of its sharp losses and is now down only about 9% year to date, Disney has not experienced as large a rebound.

DIS Chart

Data by YCharts.

Disney's forward price-to-earnings ratio has surged to 86, well above its trailing multiple of 24. However, more than becoming "expensive," this merely reflects falling earnings, which analysts expect will drop 68% in fiscal 2020. However, they also predict a 110% recovery in fiscal 2021, which would bring the multiple back down to historical levels. Hence, COVID-19 looks like a short-term headwind rather than a long-term obstacle to Disney stock.

Should you buy the stock?

With so many of its more lucrative revenue sources closed off, it may seem difficult to muster a lot of optimism for Disney. Nonetheless, investors should consider buying this media stock sooner rather than later. The company is likely to move higher once the investing public gains more clarity on when its parks, stores, and cruises can resume operations. Also, the return of live sports in the U.S. and Europe in the foreseeable future will boost ESPN and the media networks segment. At that point, the top and bottom lines will recover quickly.

CFO Christine McCarthy also said that the company would reevaluate the dividend six months from now, so investors should not assume that the company will make this suspension permanent. For investors with a little patience, Disney stock should begin to recover more of its lost value once more of its businesses can serve customers again.

Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Walt Disney and recommends the following options: long January 2021 $60 calls on Walt Disney and short July 2020 $115 calls on Walt Disney. The Motley Fool has a disclosure policy.

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