Disney: The worst is over, DTC impresses, stock is still cheap (NYSE: DIS)

Investment thesis

Disney (NYSE: DIS) shareholders had long expected these results. And those results were as bad as expected, but not worse.

Looking ahead, there’s plenty to be optimistic about Disney. Disney’s direct-to-consumer strategy not only continues to impress, but Disney is now developing a new streaming platform in international markets.

With the amount of negativity already embedded in its stock, Disney should generate upside potential of at least 30% over the next two years, returning to at least former highs.


Disney’s worst quarter is now over

Source: author’s calculations

Disney was one such company at the epicenter of COVID-related disruptions. Even if the skies aren’t clear as of now, these Q2 2020 results are probably as rough as you can get.

That’s not to say Q3 2020 will see a dramatic improvement over Q2, but there should still be “less bad news”.

From an investor’s perspective, “less bad news” is good enough to make this investment attractive.

Eyes glued to Disney+ – and now Star?

Investors had their eyes on the number of Disney+ subscribers which reached 58 million at the end of June and was within reach of 62 million at the start of this week. Investors were watching these numbers very carefully.

Remember that Netflix’s own (NFLX) forecast for Q3 2020 is close to 200 million. As a result, after years of heavy promotion, Netflix is ​​hitting a number that Disney is able to quickly sweep out of nowhere and make great strides towards.

Indeed, for so long, investors have doubted Disney’s efforts to launch its own DTC, saying that even if Disney had high-quality content, it had no way to reach consumers. Opponents argued that while “content is king”, high-quality content without strong distribution was of little value, and were unwilling to give Disney the benefit of the doubt.

Fast forward a little over a year and Disney has passed the low end of its 2024 subscriber goal – about four years earlier; while showing no signs of slowing down.

As a reminder, Disney+’s strategy is to increase the number of subscribers. This surfaced on yesterday’s call. At this time, Disney has no plans to significantly increase prices on its Disney+ platform or achieve profitability – the goal is growth.

Also, let’s not forget that while Disney+ is making headlines, Disney also has distribution for Hulu and ESPN+. In total, Disney’s comprehensive portfolio of direct-to-consumer platforms now has more than 100 million paid subscriber numbers.

In fact, looking to the future, Disney will launch its “Star” brand in international markets. Unlike Hulu which aggregates third-party content, Star will have ABC, Fox TV, FX, Freeform, Searchlight and 20th century studios.

Valuation — Addressing Upside Potential

As a value investor, one of the first rules you need to focus on is difference between risk and uncertainty, right? Rational, unemotional investors would most likely agree that there isn’t much risk in investing in $220 billion Disney.

Also, from an investment perspective, I remain intrigued that Netflix and Disney are trading at essentially the same $220 billion valuation.

In Disney’s case, you get all the high-quality Disney-produced content, but you also get the revenue stream that typically generates significant free cash flow – Parks, Experiences and Products, and Media Networks.

Also, let’s keep in mind that Netflix is ​​a pure-play streaming platform in the midst of a visceral streaming war, and we don’t know if Netflix will maintain its victorious position or end up being a victory. Pyrrhic.

From an investor’s perspective, Disney is not without its problems either. Because even setting aside COVID-related issues, such as park closures, investors are unlikely to be rewarded with a strong growth opportunity.

That said, this is where the investment gets really interesting: I argue that investors have become obsessed with strong growth opportunitiesand get rid of a perfectly strong free cash flow generating asset.

Realistically, on the one hand, we have to say that it will be some time before Disney gets back to generating free cash flow at a level close to that seen in fiscal year 2018, when cash flow Disney’s free cash flow was just under $10 billion.

On the other hand, Disney opted for growth rather than high free cash flow, and investors will reward a higher growth driver than a company producing slow growing free cash flow.

Investors should at a minimum expect Disney to have 30% upside potential and return to former highs over the next two years.

The essential

Disney’s Q2 2020 period is now over and it should only get better from now on.

Looking ahead, while we still don’t know how long until Disney Parks resumes at full speed, we can be reasonably confident that within the next 18 months Disney will be close to operating at full speed. .

However, the icing on the cake is that investors currently know that Disney’s DTC strategies are working and gaining tractionquick.

Given that the market is still looking forward, I suspect that twelve months from now investors will be thinking about 2022, and by then Disney will be back at full steam, while having a very strong line in DTC. This stock is a worthy addition to a defensive portfolio.

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