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Walt Disney - positive signs from Disney+

Emilie Stevens, Equity Analyst | 5 February 2020 | A A A
Walt Disney - positive signs from Disney+

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Walt Disney Co Common Stock

Sell: 116.71 | Buy: 116.75 | Change -4.78 (-3.93%)
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Disney's first quarter revenues rose 36% to $20.9bn, in line with market expectations. That reflects growth in every business area, boosted by the acquisition of Twentieth Century Fox and a strong start from Disney+.

However, underlying earnings per share (EPS) fell 17% to $1.53, reflecting costs associated with last year's acquisitions, including higher interest payments on a larger debt pile.

The shares were broadly unmoved in aftermarket trading.

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Our view

Last year's $71bn acquisition of Fox looks to be embedding well - though it's early days and mega mergers come with a lot of execution risk. Meanwhile the highly anticipated launch of the Disney+ streaming service is underway.

Neither are small undertakings and associated costs are weighing on profits. We'd encourage investors to take a long term view though, Disney's business model is designed to deliver over decades not months.

Disney's existing streaming businesses, ESPN+ and Hulu, give it more than a toehold in the market, but Disney+ takes things to another level. Initial launches have proven popular - with the service attracting 10m subscribers in the first 24hours in the US, beating even Disney's expectations. The sector's fiercely competitive though.

But while streaming inevitably attracts a lot of attention its important not to lose sight of what hasn't changed - after all Disney+ isn't expected to be profitable until 2024. The real profit engines are the Media Networks and Parks businesses.

Networks is home to the likes of ESPN, ABC and National Geographic. It's the second biggest earner but the most challenged. Costs are high since rights to things like the NFL don't come cheap, and earnings are exposed to the ups and downs of the advertising industry. It doesn't help that streamers (including Disney's own services) are snapping at the traditional broadcast cake. So far the group has weathered the storm.

Parks, Experiences & Merchandise is Disney's other big money maker. CEO Bob Iger continues to splash the cash on new movie attractions and guests have generally continued to queue up at the gates despite recent hikes in ticket prices. Added to this a portfolio of hotels and cruise ships helps to feed the apparently instantiable demand for all things Disney.

In many ways it's the machine behind the Parks division that makes Disney so special. A back-catalogue with some of the best copyright on the planet, can be monetised again and again, helping Disney stay cash positive despite increased investment demands.

That strength hasn't gone unnoticed however and the company's PE ratio is a lofty 25.5 times future earnings, well above the longer term average of 16.7. That's pushed the prospective yield down to 1.3%.

Despite the price tag we continue to be impressed by Disney's strength in depth. The group's ability to take content and package it for consumers across numerous platforms is hugely valuable. Having spent 2019 getting its ducks in a row, 2020 could see the start of a somewhat newer world for Disney.

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First Quarter Results

Revenues in the Media Networks business rose 24% to $7.4bn, with operating profits rising 23% to $1.6bn. The inclusion of Twentieth Century Fox boosted both the Cable Networks and Broadcasting businesses, more than offsetting lower profits in ESPN and ABC which saw costs rise.

In Parks, Experiences and Products, revenues rose 8% to $7.4bn with operating profits rising 9% to $2.3bn. This reflects higher merchandise revenues and higher spending at domestic parks, partially offset by falling profits in the international division as the Hong Kong Disneyland continued to face disruption.

Studios revenues doubled, rising from $1.8bn to $3.8bn, with operating profits coming in three times higher at $948m. This reflects Star Wars and Frozen II outperforming prior year releases in the same quarter and growth in sales to the group's streaming platforms. The Studios growth was dampened somewhat by an operating losses in Fox productions, where earnings from new releases failed to offset higher costs.

The Direct-to-Consumer & International saw revenues reach $4bn, up from $918m last year, reflecting the launch of Disney+ and consolidation of Hulu. However, losses more than tripled to $693m, reflecting costs associated with the launch of Disney+, bringing Hulu on board and higher programme costs at ESPN+.

Net debt more than doubled year-on-year, rising to $41.2bn, reflecting last year's acquisition of Fox. However, compared to the prior calendar quarter net debt remained broadly level.

Free cash flow fell to $292m, down from $904m the prior year, reflecting higher content production spending and increased investments in parks and resorts.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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