Walt Disney (DIS 1.01%) stock has been a major disappointment for investors thanks to factors outside and within the company's control. Over the past 10 years, Disney stock has produced a 56% return compared to 187% for the Dow Jones Industrial Average and 220% for the S&P 500. The underperformance may come as a surprise given that some of Disney's greatest box office hits, including Avengers: Endgame, Avengers: Infinity War, and Star Wars Episode VII: The Force Awakens, were released during this period. And in terms of box office revenue, 2012 to 2019 marked the heyday for the Marvel and Star Wars franchises.
But the COVID-19 pandemic's impact on park attendance, paired with a shift in expectations for streaming companies from subscriber growth to profit, drove Disney stock to close at an eight-year low of $84.17 on Dec. 28, 2022, erasing all of the gains that came from the initial embrace of Disney+.
It's easy to focus on the bad. Disney is facing brand pressure and Hollywood strikes, has had some recent box office flops, and continues to lose money on Disney+. Its business largely depends on consumer discretionary spending, which is challenged by rising interest rates. But Disney is making some noteworthy improvements. Here are five bright green flags that stick out from the company's recent fiscal third-quarter earnings call with analysts, and why the media stock is a buy now.
Image source: Getty Images.
1. Streaming losses narrow
The most encouraging point on this earnings call was that Disney is losing less money from its direct-to-consumer (DTC) business. Granted, it still suffered a $512 million operating loss in the segment, but that was far lower than the $1.06 billion from the same quarter last year. Disney reiterated its goal to make DTC profitable by late 2024.
The path to profitability for Disney+ is likely to feature ongoing declines in paid subscribers, but also less content spending. It's the exact opposite strategy that Disney went for when it first launched the platform.
CEO Bob Iger has made it clear that the focus isn't on revenue growth or subscribers, but on profitability. And if Disney+ and the other DTC offerings become smaller (from a budget perspective) in the process, that's fine.
What we are seeing with Disney+ is a resetting. The parks and Disney's traditional media and cable business, which it refers to as linear networks, can't keep offsetting the losses from Disney+. Eventually, it's going to have to be Disney+ that helps offset profit declines at linear networks.
NYSE: DIS
Key Data Points
2. A focus on quality
Disney was direct about its underperformance at the box office and its mistake to overproduce content on Disney+. However, Iger said he's working on fixing the problems:
The studio has had a tremendous run over the last decade, perhaps the greatest run that any studio has ever had with multiple billion-dollar hits ... That said, the performance of some of our recent films has definitely been disappointing, and we don't take that lightly. And as you'd expect, we're very focused on improving the quality and the performance of the films that we've got coming up. It's something that I'm working closely with the studio on. I'm personally committed to spending more time and attention on that as well.
Of course, saying and doing are two different things. Looking at Disney's content slate for theatrical releases and Disney+ and Hulu releases, there just isn't a lot of showstopper material out there, which could lead to ongoing disappointment.
Losing money on Disney+ because it grew too quickly is one issue, but having a lapse in creative direction is a much more serious problem. It's a situation that reminds me of something Iger talked about in his book The Ride of A Lifetime. When Iger took over as CEO in 2005, Disney Animation was lacking creativity, and the company felt compelled to acquire Pixar, and then later Marvel and Lucas Films, to fill the void. The strategy worked out, namely because Disney got such a great price on those companies and delivered at the box office. But it's facing a tall order, and Disney may need to simply do better on its own than rely on an acquisition to bail it out this time around.
The bright green flag is that Iger is openly addressing the problem and is committed to solving it. Oftentimes, management teams will downplay issues as a way to appease Wall Street, but Iger has a track record of tackling problems head-on as quickly as possible.
Since storyboarding, filming, editing, developing, and releasing a show or movie takes time, Disney's content slate for the next year to two years is mostly already accounted for, so it's unlikely we will see meaningful progress on the creative front until fiscal 2026.
This lag factor is bad news for Disney in the short term, but it does chart a path toward a turnaround. And most importantly, Iger will have time to make the turnaround a reality since he will be CEO until at least the end of 2026.
3. An intense focus on profitability
Disney's content spend is on track to be $27 billion for fiscal 2023, which is less than the over $30 billion it guided for near the end of last year. It initially expected to spend $6.7 billion in capital expenditures in fiscal 2023 but now expects that number to be just $5 billion.
Iger's messaging in the last couple of earnings calls has been crystal-clear. The company's mission is to boost profitability, which makes sense at most companies, but it's a little different for a company like Disney, which has had a long history of creative folks clashing with the finance side of the business. It would be a mistake to get so obsessed with penny-pinching that it hinders the imaginative spirit that is essential in making epic rides and lasting memories that keep people spending. But overall, cutting expenses is the right move for Disney, which needs to get back to its blue chip roots and not overextend like in years past.
4. A resurgence in free cash flow
It's not just profitability that Iger is focused on. The company notched $1.64 billion in free cash flow (FCF) in Q3 on top of $2 billion the prior quarter. For the nine months ended July 1, Disney earned $1.47 billion in FCF (after a big loss in Q1) compared to negative $317 million in FCF for the nine months ended July 2, 2022. These are positive numbers.
5. A returning dividend
Returning the business to consistent positive FCF supports future buybacks and dividends. As promised earlier this year, Disney said it will reinstate its dividend next quarter. Disney's interim CFO, Kevin Lansberry, said it would be a "modest" dividend.
For now, the dividend isn't so much about the amount but what it symbolizes, which is a return to Disney being focused on stability and regimented growth instead of aggressive risk-taking.
The right direction
Disney's 2019 acquisition of 21st Century Fox and its all-in growth strategy for Disney+ were big mistakes that largely fell under the watch of Bob Iger. But since coming out of retirement to right the ship, Iger clearly understands what needs to be done with the company to restore faith on Wall Street and regain investor trust. Disney stock is likely to remain challenged for a while, but the necessary steps are being taken and the company is showing signs of accountability and responsibility for the stock's abysmal performance.
If you're a believer in Disney's ability to execute its plan, then buying the stock now makes a lot of sense. But taking a wait-and-see approach is also understandable. The tipping point will be if Disney makes good on its promise to turn Disney+ profitable by the end of fiscal 2024 (which ends Sept. 28, 2024). If it hits that goal, then it's going to be a huge sign that Disney is returning to growth. And if it misses the goal, it's going to be yet another reason why investors will prefer to wait on the sidelines than take a chance on Disney.
