There's no question that Disney (DIS -0.45%), the brand, is one of the most valuable in the world.
The name has been synonymous with family entertainment for nearly a century, and its library of intellectual property, ranging from Mickey Mouse to Marvel, is unrivaled.
However, Disney, the company, is facing one of the greatest challenges in its history as, like other legacy media companies, it tries to navigate the transition from traditional cable and broadcast media to streaming.
Thus far, it's been a rocky journey. While the Disney+ service has been a hit with consumers, it's been a drag on the bottom line. The recent price hike in Disney+ and cost cuts from the company have helped stanch some of the bleeding at the flagship streaming service, but there's still much work to be done. Its direct-to-consumer segment reported a loss of $659 million in the just-ended fiscal second quarter, which was a moderate improvement from a loss of $887 million in the quarter a year ago and a $1.1 billion loss in the previous quarter.
Meanwhile, its traditional linear networks business saw revenue decline 7% to $6.6 billion and operating income fall 35% to $1.8 billion, a result of cord-cutting, a weak advertising market, and higher prices for sports broadcast rights on ESPN and ABC.
The chart below illustrates the company's performance in the fiscal second quarter.
Image source: The Motley Fool.
As you can see, its media and entertainment division struggled, barely growing revenue in the period, while the parks business continued to thrive.
Investors were unhappy with the results. Though Disney met estimates with revenue of $21.8 billion and adjusted earnings per share of $0.93, the stock was trading down 4.5% after hours on Wednesday.
As the company has progressed in its transition from linear to streaming media, the stock has floundered, lagging the S&P 500 in virtually every meaningful time interval over the last five years.
However, according to one popular investing approach, the stock looks like a bargain.
The sum of the parts
Disney is a complex company with several large businesses, including its cable and broadcast networks, streaming services, studio entertainment, theme parks, and consumer products like toys.
One way to value this kind of business is to break it up into individual segments, value each one separately, and add them together. This approach is known as the sum of the parts.
Disney operates in two primary segments: media and entertainment, which encompasses video content across networks, streaming, and movies; and parks, experiences, and products, which includes theme parks, resorts, and cruises, as well as consumer products.
While the media business is struggling, the parks segment has been on fire, growing second-quarter revenue 17% to $21.8 billion, and operating income, which doesn't include corporate expenses, 23% to $2.2 billion. Even factoring in those corporate costs, operating income would be roughly $1.5 billion in the quarter, or an annual run rate of $6 billion.
Disney's market cap is about $175 billion now, which could be a reasonable valuation for just the parks business as it's growing the top and bottom line by roughly 20%, has outstanding pricing power and name recognition, and is generating that $6 billion in operating income a year.
Is Disney stock a bargain right now?
It's a stretch to say that investors are getting Disney's media business for free right now, but it does appear to be priced like a bargain given the strength of the parks business.
The price hike at Disney+ seems to have been absorbed with little resistance, leading CEO Bob Iger to observe that the service has price elasticity. Meanwhile, the new ad tier should gain traction with the ad sales upfronts coming in a few weeks. Cost controls should also help further improve the bottom line.
It will be difficult for the Disney media business to return to its former peak profitability, but the potential is there, especially as movie attendance continues to recover.
Investors are clearly impatient with the pace of a recovery, but Disney should get there eventually. If it can pull off the transition to streaming, the entertainment stock has a lot of upside ahead of it.
