Walt Disney (DIS +0.41%) stock is one of my oldest holdings, and it's been a horrible underperformer in my portfolio since 2014. It's had its moments, and I've happily added to my holdings over time.
But the last earnings report -- Disney's fourth quarter of 2022 (ended October 1) -- gave me serious pause. Incoming CEO Bob Iger, who previously orchestrated deals to acquire Pixar, Marvel, and Lucasfilm, and got Disney+ up and off the ground, has his work cut out for him.
NYSE: DIS
Key Data Points
I've decided not to cut my stake in Disney yet, but I see three serious red flags that need to be fixed ASAP.
1. Disney is suffering from a lack of focus
Walt Disney has always been a tough business to unpack. It has a myriad of different business segments (theme parks and experiences, movie production, traditional TV, streaming TV, etc.), and multiple levers from which to monetize its intellectual property (advertising, subscriptions, ticket sales, licensing fees).
However, in years past under Iger, shareholders were given clear-cut metrics to keep an eye on to measure the media empire's profitable growth. When Pixar, Marvel, and the Star Wars properties were being integrated into the mix, a steady slate of theatrical releases were moving the needle. Later, it was progress in getting the streaming service Disney+ launched. And along the way, broadcast and cable TV (ABC, ESPN) and theme parks were a slower-moving but highly profitable moneymakers.
The pandemic certainly threw a wrench in the gears, but Disney should be more than fine. Households are salivating for entertainment, be that a vacation or something close to home. The problem is that during the last three years under previous CEO Bob Chapek, I've been feeling increasingly confused about what I should focus on.
Streaming subscribers increased by 57 million in the last year (for a total of 235 million across Disney+, ESPN+, and Hulu), a 32% increase. But actual revenue growth fell far short of that, increasing only 20%.
The company's theme parks and experiences segment, especially in the U.S., is killing it. However, profit results (more on that momentarily) fell short of my expectations because of heavy investment in cruise ships -- and all the while theme park ticket prices have been going up.
Movie and TV content creation are up and running again. But though content sales and licensing revenue grew 11% in the last year, the segment lost money (a $287 million operating loss on revenue of $8.15 billion). So much for a return to movie theaters being a good thing.
The only segment with satisfying results is "linear networks" -- broadcast and cable TV stations like ABC and ESPN. But that's no business growth driver. And though it's highly profitable, instead of those profits getting doled out via a dividend or share repurchases (remember, Disney did away with its dividend), they're being funneled into the messy strategies outlined above.
Suffice it to say the business is convoluted right now. Iger's first order of business needs to be narrowing Disney's focus on what matters most, and then executing on clearly communicated goals.
2. Time to adjust the streaming business model
In years past, growing subscriber counts at Disney+ and the other streaming properties had Disney stock soaring. These days, the streaming segment arguably looks like a massive waste of money that's draining the value of adjacent business segments.
Of course, we were always told that 2022 would be peak losses for the streaming segment. Turns out that meant an operating loss of over $4 billion, even steeper than the $1.68 billion loss streaming TV generated last year. Management has said streaming will reach breakeven sometime in 2024, but I'm not buying it.
Remember I mentioned that the content sales and licensing segment swung to a loss this year? Much of that has to do with the decision to slow the sale of content rights to third parties and instead putting that content on Disney+, Hulu, etc. So not only is the streaming segment not pulling its weight (revenue is stalling, and losses are widening), but it's now also cannibalizing the value from another area of the business.
Further, a new ad-supported tier is coming to Disney+ in December 2022. This was exciting at first, but given the ongoing losses in content creation and now also at content distribution, I'm now thinking that introducing an ad-supported tier will simply further cannibalize the streaming business, rather than help fuel its profitable growth.
It's clear that the current streaming strategy isn't working, even as Disney+ and its sister online TV networks reach massive scale. Time to start experimenting with the business model.
3. Profitability is nowhere near satisfactory
As effects of the pandemic waned, I had high hopes for a massive rally in Disney's overall bottom line. But a more dramatic rally never transpired. Net income increased 58% year over year in 2022, but came in at just $3.19 billion -- a pitiful 3.9% net profit margin. Free cash flow, which backs out capital expenditures on property and equipment, actually fell 47% from 2021 levels to just $1.06 billion.
Here's but one example of what happened. Blame streaming TV for big losses, sure, but buried in the press release was a $1.1 billion jump in parks and experiences capital expenditures. If this was earmarked to go toward support of its actual theme parks -- world-class real estate assets that families love to visit on vacation -- fine. But it wasn't. It was cruise ship spending.
Which brings us full circle here. A lack of focus is drying up Disney's bottom line. If the economy is headed for a recession in 2023, Disney is currently not operating from a position of strength. Iger making a return as CEO has me willing to exercise some more patience. However, there are a lot of problems that suddenly need to be addressed, and quickly.
In the meantime, there are other, more focused travel and entertainment stocks faring much better as 2022 draws to a close.
