In response to lower inflation and a softening labor market, the Federal Reserve decided to lower its benchmark interest rate by 50 basis points for the first time in four years on Sept. 18. Here's why lower interest rates could help Walt Disney (DIS +1.01%) improve its profitability and deliver on shareholder expectations, and why the value stock is a buy now.
Image source: Getty Images.
A roller coaster to forget
Disney launched its long-awaited streaming service, Disney+, in November 2019. Disney+ was meant to accelerate growth and provide a clear transition away from cable -- which Disney refers to as linear networks.
The multifaceted approach of the parks, box office hits, Disney+, merchandise, and still highly profitable linear networks had the potential to bring Disney to new heights. And briefly, it did, as Disney stock hit an all-time high of more than $200 a share in early 2021, even as the COVID-19 pandemic took a sledgehammer to its parks business.
But behind the veil of Wall Street euphoria were some serious problems, the first of which was Disney's balance sheet. The company's debt skyrocketed to fund Disney+ and manage the pandemic-induced parks slowdown. Even today, Disney's long-term debt remains at elevated levels.
DIS Net Total Long Term Debt (Quarterly) data by YCharts
Disney had regularly returned capital to investors through buybacks and dividends. But in fiscal 2020, it paused its payout and reported its first net loss in over 40 years. Investors were willing to tolerate these red flags under extenuating circumstances, but there was pressure building for Disney to get back to its pre-pandemic groove. Unfortunately, that didn't happen.
Disney failed to land the box office hits that investors were used to from franchises like Marvel and Star Wars. A flurry of content spending to grow Disney+ added to the losses.
In just a few years, Disney went from a reliable blue-chip dividend stock to a company with mounting debt, no dividend, falling earnings, and negative growth. Disney recently reinstated its semi-annual dividend, but at a fraction of its previous level, as Disney yields just 1%.
Since returning as CEO in November 2022, Bob Iger has been cutting costs and steering Disney toward improved profitability. Iger and the rest of the management team have been doubling down on the parks, Disney's true cash cow, and focusing on content quality over quantity, which has slowed the rate of theatrical releases and streaming content.
As a result of the efforts, Disney's earnings have been climbing, and Disney+ hit its long-awaited operating profit earlier this year, with expectations for even greater profits ahead thanks to price increases. Disney's forward price-to-earnings ratio is now just 18.8 due to projected earnings growth and Disney's beaten-down stock price.
Disney was up more than 30% year to date earlier this year -- but has since given up nearly all of those gains. The company is now up a little over 5% in the last 10 years compared to a 190% gain in the S&P 500 -- highlighting just how poor of an investment Disney has been.
NYSE: DIS
Key Data Points
Boosting consumer spending
When a stock underperforms by a wide margin for an extended period, investors may (rightfully) grow skeptical of a lasting turnaround. In addition to the improved profitability of Disney's streaming business, lower interest rates could be the catalyst the company needs to regain Wall Street's favor.
From an operational perspective, lower interest rates will reduce Disney's cost of capital and can help it refinance debt or take on new debt at a lower price. More importantly, lower interest rates could spur consumer discretionary spending.
Disney is a textbook example of a cyclical business. When consumers are in good financial shape, they may decide to book a visit to a Disney park or cruise ship, see a movie in theaters, or subscribe to Disney+ and stomach price increases. But when consumer spending is down, expensive vacations and entertainment expenses get cut, which can lead to delayed vacations or an intolerance to streaming price increases.
Disney has endured many cycles throughout its over 100-year history. However, the business is fundamentally different today than in past decades. More than ever, Disney is relying on its intellectual property treasure trove to drive loyalty.
Fanfare for the characters and stories of Disney's past works are more important for driving park visitors than any new content it creates. Similarly, access to Disney's content library is a cornerstone of the value of a Disney+ subscription.
Disney has fallen far enough
Although lower interest rates could help turn Disney's business around, it's important to understand why the Fed is lowering interest rates in the first place.
Unemployment is increasing, and inflation is cooling. Credit card debt, mortgage interest rates, and housing prices are at elevated levels. Lower interest rates can help spur economic growth and help consumers manage debt. But if lower interest rates lead to a return to high inflation and contribute to a recession, it could present even more challenges for companies like Disney.
Therefore, investors should only consider Disney stock if they agree with the company's strategic direction, believe in the value of its intellectual property, and are willing to hold the stock through periods of volatility.
