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Disney - stellar streaming offsets parks problems

Nicholas Hyett, Equity Analyst | 13 November 2020 | A A A
Disney - stellar streaming offsets parks problems

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Walt Disney Co Common Stock

Sell: 195.28 | Buy: 195.39 | Change 1.40 (0.72%)
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Full year revenues came in at $65.4bn, down 6% year-on-year but better than analysts had feared. The relatively modest revenue decline reflects rapid growth in Direct-to-Consumer and International, and progress in Media Networks, which offset most of the pandemic related disruption in Parks and Studios.

Operating profits fell 45% to $8.1bn, again better than analysts had expected. The decline was largely driven by the Parks business falling from a $6.8bn profit in 2019, to an $81m loss this year. Losses also mounted in Direct-to-Consumer and International as costs increased following the launch of Disney+.

The group reported an underlying loss per share of $1.57 - reflecting higher interest charges and $5.7bn of restructuring charges.

Disney shares rose 5.5% in after-hours trading.

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Our view

The pandemic has gutted Disney's Parks, Experiences & Products division. With several parks still closed, and those that are open operating at a vastly reduced capacity, the division reported an operating loss of $1.1bn in the final quarter of the year.

It doesn't help that profits were already struggling before the pandemic struck. Restructuring cost associated with the Fox deal have stretched into the billions, while investment in Disney+ has seen costs rise.

There are positives though. Cancelled sports events and delays to filming have reduced costs in the Media Networks business (which owns the likes of ABC and ESPN) and together with increased pricing that's boosted a division that's long been the single largest contributor to group profit.

However, the real story at the moment is the massive ramp up in direct-to-consumer (DTC) revenues. Disney+ launched a year to the day before 2020's full year results and in that time ramped up nearly 74m paying subscribers. The group's other streaming services, ESPN+ and Hulu have also dramatically increased their subscriber numbers, with the result that DTC revenues are up 81% year-on-year.

The DTC division is loss making at the moment, and with marketing and content expenses rising, is likely to remain so for some years to come. That trend will probably continue for some time, and management are throwing ever more resource at its owned channels.

In October Disney announced a major restructure of its main content production and distribution businesses to focus the group's creative juices on feeding direct-to-consumer businesses. The idea is that creative divisions can focus on creating while purely commercial matters, like the best route to market, can be decided by a commercially focused team. That aims to increase flexibility and is a clear indication that while broadcast and cinema remain important for now, the expectation is they'll eventually be playing second fiddle to Disney's streaming operations.

All those changes are a clear bet on a digital first, streaming centric, future. It's a big gamble for a company which isn't in the best of financial health.

Last year's $71bn acquisition of Twenty First Century Fox loaded the business up with debt. That's increased interest expenses by 52% this year, an extra burden that must be met despite lower profits and adds to the execution risks that always come with mega mergers. For now we're comforted by the fact Disney has substantial cash on the balance sheet and despite the scale of the disruption was able to keep cash flow comfortably positive.

While 2020 has not been a pretty year for the House of Mouse, the group still holds plenty of long term potential in our view, perhaps best demonstrated by the success of Disney+. The power of Disney's unparalleled stable of copyrights and brands can't be overstated, and will stand it in good stead in the long-run. Our feeling remains that coronavirus is a bump in the road, not a derailing of the investment case.

Just a quick note on valuation here. You may notice from the box below that the group PE ratio is currently well above the long-term average. However, that's based on the lower level of profits next year from coronavirus disruption. Looking at the shares on a price to book ratio (not an ideal metric for an intellectual property heavy business like Disney) the shares trade on 2.7 times book value, compared to a longer term average of 2.9. That's probably a more accurate reflection of valuation at the moment, with investors reasonably upbeat considering the short term challenges ahead.

Disney key facts

  • Price/Earnings ratio: 50.2
  • 10 year average Price/Earnings ratio: 18.4
  • Prospective dividend yield (next 12 months): 0.9%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Full Year Results

Media Networks benefitted from an additional week in the quarter and increased pricing, driving a 14% increase in revenue which reached $28.4bn. Lower programming costs due to pandemic disruption meant profits rose 21% to $9.0bn.

In Parks, Experiences and Products sales fell 37% to $16.5bn, with Disneyland Resort and the Disney cruise line still closed. Shanghai re-opened in May, with Florida and Paris reopening in mid-July and Hong Kong opening for three weeks.

The Studios business reported a 13% revenue decline to $9.6bn, with operating profits down 7% to $2.5bn. That reflects the fact many cinemas were shut for large portions of the year, although lower marketing expenses helped offset that at the operating profit level.

In Direct-to-Consumer Disney+ reported paid subscribers of 73.7m, with ESPN+ subscribers almost tripling to 10.3m and Hulu customers up 28% to 36.6m. Revenues in the division rose 81% to $17.0bn, but additional costs meant operating losses increased from $1.8bn a year ago to $2.8bn in 2020.

Disney reported $3.6bn of free cash flow, representing a significant improvement year-on-year as the group cut back on capital expenditure and benefited from lower taxes. The group reported net debt of $40.7bn at the end of the year, down from $41.6bn a year ago.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.