The last four years have been a wild ride for Walt Disney (DIS -0.04%). Investments to support its digital-first transition have been costly. Disney's quarterly net income of $264 million is well off course from the $5.4 billion reported before the pandemic. That's why the stock is 52% off its high.
The reason the stock could be undervalued right now is that the company isn't experiencing a demand problem. Its core entertainment business -- parks and streaming services -- is growing. The problem areas are largely centered around the returns the company is earning on capital spending. It simply needs to be more efficient with expenses.
Here's where Disney is making progress to fix the issue, and what it will take to move the stock higher.
Demand for Disney is strong
The company's losses sent the stock down, but higher profits can send it back up. The biggest hole for Disney financially has been the direct-to-consumer (DTC) business, including revenue from Disney+ and Hulu.
Disney+ is performing well from a demand perspective. In the September-ending quarter, it added 7 million new subscribers, pushing DTC segment revenue for the quarter up 12% year over year to $5 billion, which also benefited from higher pricing.
Most importantly, Disney reported a $1 billion improvement in operating loss, which puts its streaming business on track to turn a profit by the end of September, as originally planned.
What's more, the company might have further pricing power to grow margins. Disney+ is adding a healthy amount of subscribers even as the plan without ads is $13.99 -- slightly lower than Netflix's $15.49 per month.
Even with the cheaper $7.99 ad-supported plan, customers are not balking at paying a higher price than Netflix. The company reported that half of new Disney+ subscribers are opting for the ad-supported plan despite its costing $1 more than Netflix's ad plan.
Disney's content is unique and valuable. This shows up in box office numbers, where it had four of the 10 top-grossing films last year. It's also showing up at the theme parks, which are generating significantly higher revenue and profits than before the pandemic. This is why Disney stock is worth buying below $100, but there are still other issues that could limit its gains this year.
What will send Disney stock up?
The weak results at Disney's TV networks (like ABC and ESPN) have been a drag on the company's growth. A weak advertising market sent network revenue down 9% year over year in the September-ending quarter.
But the strong growth in the rest of the business means the networks are contributing less to Disney's total revenue, which grew 5% year over year in the September-ending quarter.
A bigger problem is the company's debt burden. Disney took on a lot of debt to finance the acquisition of Fox's entertainment assets a few years ago. Long-term debt stood at $46 billion in September, which doesn't look good when the company's profits have deteriorated.
Data by YCharts.
While Disney generated almost $10 billion in cash from operations in fiscal 2023 and is sitting on $17 billion of cash and investments to offset the debt, the financial hole makes the stock look more expensive.
Adding Disney's net debt to its market cap (share price times total shares outstanding), the stock is trading at 14.6 times the company's fiscal 2019 operating income. This is higher than the stock's average valuation of 12.3 times operating income over the last decade.
So even if Disney returned to pre-pandemic levels of profitability, roughly $15 billion in annual operating profit, the stock still doesn't look cheap enough to justify significant upside. But if you're patient, the stock should move higher as management pays down debt, reduces interest expense, and improves the economics of the streaming business.
