Disney’s Prospects – the Morningstar View

Where
does
this
leave
investors?
The
company
released
its
third-quarter
and
nine-month
earnings
report
last
week.
After
a
look
at
the
books,
Morningstar
has
revised
its
fair
value
estimate
for
the
company’s
share
price.
Here’s
our
take
on
Disney’s
earnings.

Morningstar’s
Take

Revenue
improvement:
Disney
posted
a
solid
fiscal
third
quarter
as
streaming
losses
continued
to
shrink,
but
Disney+
and
Hulu
delivered
very
weak
subscriber
numbers.
Total
revenue
improved
by
4%
year
over
year
to
$22.3
billion
as
the
growth
at
parks
and
direct-to-consumer
outweighed
the
declines
at
the
linear
networks
and
studios
businesses.

More
subscriber
growth
needed
from
streaming:
Even
as
the
streaming
segment
remains
on
course
to
break
even
by
the
end
of
fiscal
2024,
we
still
believe
Disney
needs
to
drive
stronger
top-line
growth
to
replace
declining
linear
networks
revenue.
While
the
just-announced
price
increases
are
one
lever
for
driving
revenue
growth,
we
think
subscriber
growth
will
also
be
required
over
the
medium
term.

Fair
Value
Estimate
for
Disney

With
its
4-star
rating,
we
believe
Disney’s
stock
is
undervalued
compared
with
our
long-term
fair
value
estimate.

Our
updated
$145
fair
value
estimate
for
Disney
(lowered
from
$155
in
May)
reflects
slower
subscriber
growth
and
lower
losses
from
streaming.
We
expect
average
annual
top-line
growth
of
6%
through
fiscal
2027.
We
now
project
losses
for
the
streaming
segment
to
continue
through
fiscal
2024,
for
linear
advertising
to
decline
over
the
next
five
years,
and
for
a
continued
decline
in
linear
networks
margins.

We
expect
that
fiscal
2023
admissions
revenue
will
remain
ahead
of
fiscal
2019,
despite
consumer
worries
about
the
economy
and
inflation.
We
project
that
merchandise,
food,
and
beverage
revenue
will
see
similar
growth,
as
will
resorts
revenue.
The
parks
and
consumer
segment
suffered
a
37%
decline
in
revenue
in
fiscal
2020
and
a
3%
decline
in
fiscal
2021.
Following
a
strong
bounce
back
of
73%
in
2022,
we
expect
more
normalized
growth
of
5%
over
the
next
five
years.

We
estimate
12%
average
annual
growth
for
the
direct-to-consumer
segment,
as
we
are
modelling
strong
subscriber
growth
for
Disney+
and
Hulu,
along
with
further
price
increases.
We
now
project
that
Disney-branded
streaming
services
will
hit
235
million
paid
subscribers
by
the
end
of
fiscal
2027.
This
growth
assumes
a
continued
international
rollout
and
improved
penetration
in
the
larger
Western
markets.
We
project
that
the
segment
will
post
its
first
positive
annual
operating
income
in
fiscal
2025.

Economic
Moat
Rating

We
assign
Disney
a
Wide
Economic
Moat.
Its
media
networks
segment
and
collection
of
Disney-branded
businesses
have
demonstrated
strong
pricing
power
over
the
past
decade.
We
believe
that
the
assets
brought
on
by
the
firm’s
acquisition
of
20th
Century
Fox
in
2019
will
continue
to
help
it
generate
excess
returns
on
capital
despite
the
increasingly
competitive
media
marketplace,
including
within
the
streaming
landscape.

Despite
changes
in
consumer
behaviour,
the
company’s
pay-television
penetration
remains
above
60%
of
US
households.
Disney
networks
remain
important
pieces
in
the
traditional
pay-TV
bundle.
While
cord-cutting
remains
an
ongoing
issue,
premier
cable
networks
like
ESPN
and
FX
still
generate
significant
cash
flows
from
both
affiliate
fees
and
advertising,
with
price
increases
historically
outpacing
customer
losses.
The
firm’s
roster
of
networks
provides
distributors
with
general
entertainment,
live
sports
at
ESPN,
and
news
coverage
at
ABC
–
two
genres
keeping
many
subscribers
in
the
pay-TV
universe.
While
we
expect
pay-TV
subscribers
to
continue
to
decline
annually,
the
underlying
networks
remain
profitable,
and
the
cash
generated
will
continue
to
be
reallocated
to
support
Disney’s
DTC
efforts.

ESPN
is
the
dominant
player
in
US
sports
entertainment.
Its
position
and
brand
strength
empower
it
to
charge
the
highest
subscriber
fees
of
any
cable
network,
generating
durable
profits.
ESPN
uses
these
profits
to
reinforce
its
position
by
acquiring
long-term
sports
programming
rights
for
organisations
including
the
NFL,
the
NBA,
and
college
football
and
basketball.
The
ESPN
brand
has
been
extended
to
create
the
pre-eminent
sports
news
website
(ESPN.com)
and
streaming
service
(ESPN+).
While
the
decline
in
subscribers
at
traditional
distributors
has
hurt
ESPN’s
revenue,
the
channel
is
a
core
network
for
every
major
pay-TV
distributor
–
traditional
or
online
–
despite
its
high
fees.
Given
the
importance
of
live
sports
to
the
pay-TV
bundle,
we
expect
that
the
main
ESPN
channels
will
remain
key
components
of
any
such
offering.

The
continued
strength
at
Disney’s
studios
and
media
networks
should
help
drive
continued
success
for
the
firm’s
DTC
ambitions.
While
management
is
focused
on
moving
the
segment
toward
profitability
by
the
end
of
fiscal
2024,
we
expect
the
firm
will
continue
to
invest
in
creating
original
content
for
its
streaming
platforms
while
also
placing
its
most
valuable
second-run
programming
on
those
services.
We
expect
further
investment
in
non-English
local
language
content
as
Disney+
attempts
to
gain
traction
outside
of
English-speaking
countries
and
India,
where
the
majority
of
its
content
spending
has
historically
been
done.
The
success
of
Netflix
in
Latin
America,
Central
and
Eastern
Europe,
and
South
Korea,
along
with
Disney+
in
India,
demonstrate
the
value
of
local
language
content.

Risk
and
Uncertainty

On
the
basis
of
the
competitive
linear
and
streaming
media
markets
that
Disney
operates
in,
along
with
the
level
of
advertising
and
parks
revenue
that
is
exposed
to
the
economy
and
economic
cycles,
we
believe
a
High
Morningstar
Uncertainty
Rating
is
currently
more
appropriate
than
Medium
to
better
reflect
the
volatility
we
expect
Disney
investors
will
face
relative
to
our
global
coverage.

Disney’s
results
could
suffer
if
the
company
cannot
adapt
to
the
changing
media
landscape.
Basic
pay-TV
service
rates
have
continued
to
increase,
which
could
cause
consumers
to
cancel
their
subscriptions
or
reduce
their
level
of
service.

The
company’s
ad-supported
broadcast
networks,
along
with
its
theme
parks
and
consumer
products,
will
suffer
if
the
economy
weakens.

DIS
Bulls
Say

The
parks
and
resorts
segment
will
rebound
strongly
from
the
pandemic,
as
families
still
view
the
company’s
parks
as
prime
vacation
destinations.

Disney+
has
a
long
runway
for
growth
both
in
the
United
States
and
internationally.
The
firm’s
original
series
and
the
deep
and
constantly
expanding
library
will
drive
this
growth.

Although
making
movies
is
a
hit-or-miss
business,
Disney’s
popular
franchises
and
characters
reduce
this
volatility
over
time.
Additionally,
the
firm’s
annual
release
slate
does
not
generally
rely
on
one
big
picture,
reducing
the
downside
of
a
flop.

DIS
Bears
Say

The
business
model
for
the
media
networks
division
depends
on
the
continued
growth
of
affiliate
fees.
Any
slowdown
in
the
growth
of
these
fees,
as
pay
television
subscribers
continue
to
decline,
could
tremendously
hit
profitability.

The
streaming
space
is
becoming
increasingly
crowded.
Disney
may
need
to
continue
to
fund
losses
in
this
segment
beyond
fiscal
2024.

Developing
mass-market
hit
programs
can
be
unpredictable,
especially
as
media
fragmentation
continues.
The
race
to
attract
and
retain
talented
creatives
has
been
and
will
remain
very
competitive
and
expensive.

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