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Disney - mixed picture, but better than expected

Nicholas Hyett, Equity Analyst | 12 February 2021 | A A A
Disney - mixed picture, but better than expected

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Walt Disney Co Common Stock

Sell: 176.01 | Buy: 176.02 | Change -0.25 (-0.14%)
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Disney's first quarter revenues fell 22% to $16.2bn, marginally better than analysts had expected. That reflects significant progress in the direct-to-consumer business, offset by continued disruption in theme parks.

Operating profit fell 67% to $1.3bn, as Parks moved into a significant loss, while restructuring and accounting charges relating to the Twenty First Century Fox deal meant reported profits fell 99% to $29m. Despite this operating profits were significantly ahead of analyst expectations.

The shares rose 3.2% in aftermarket trading.

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Our view

The first quarter has followed much the same pattern as we saw last year.

The pandemic continues to decimate Disney's parks and hospitality business - with several parks still closed, and those that are open operating at a vastly reduced capacity. Given the significant quantities of debt associated with building a world class resort, shutting the doors for a long period is financially painful- even after brutal and high-profile job losses.

That's being partially offset by rapid growth in the group's streaming services. Disney+, which has racked up nearly half of Netflix's subscribers in little over a year, is once again the group's knight in shining armour. Throw in ESPN+ and Hulu, and Disney is now approaching 150m subscribers, 75% of Netflix's current total. Overall the streaming business is still significantly loss making, but those losses are narrowing.

However, we think the underappreciated hero in these numbers - as they have been throughout much of the pandemic - is the less glamourous, but robust broadcast and cable businesses. Revenues have proven remarkably resilient - all the more so when you consider how crucial advertising is to results. The division accounted for almost half of group revenues and the vast majority of profits.

Over time the balance of power will slowly shift away from cable and broadcast. But it's this diversity which is proving crucial to Disney's success and indeed survival during the pandemic. An excellent content catalogue, whether that's Princess in Parks or Quarterbacks on ESPN, is one thing - but Disney's ability to sell those products through a variety of channels, multiplies the benefit many times over.

In the long term the shift to digital is both inexorable and expensive. The cost of producing high quality content for a streaming audience is high, especially when the balance sheet isn't in the best of financial health.

The $71bn acquisition of Twenty First Century Fox loaded the business up with debt. That increased interest costs by 52% last year, a burden that must be met despite lower profits, adding to the execution risk that always come with mega mergers. For now we're comforted by the fact Disney has substantial cash on hand; but if the negative free cash flow reported in Q1 continues throughout the year management could find content costs increasingly burdensome.

There's no getting away from the fact the pandemic has been hard on Disney. However, the group still holds plenty of long-term potential in our view. The power of Disney's unparalleled stable of copyrights and brands can't be overstated, and should stand it in good stead in the long-run. Our feeling is that coronavirus is a bump in the road, not a derailing of the investment case.

Just a quick note on valuation here. You'll notice from the box below that the group's PE ratio is currently well above the long-term average. The stellar valuation is partly down to the pandemic depressed earnings expected this year, but also reflects a genuine investor enthusiasm for Disney's direct to customer streaming service. It's a vote of confidence by the market, but also sets Disney a high bar for success.

Disney key facts

  • Price/Earnings ratio: 74.6
  • 10 year average Price/Earnings ratio: 19.7
  • Prospective dividend yield (next 12 months): 0.6%

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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First Quarter Results

Media and Entertainment Distribution saw revenues fall 5% to $12.7bn, as the group saw Cinema and home video sales fall 56%. That was offset by a 73% increase in Direct-to-Consumer sales, now at $3.5bn, as Disney+ subscribers more than tripled to 94.9m, ESPN+ subscribers rose 83% to 12.1m and Hulu subscribers rose 30% to 39.4m. Operating profits in the division fell 2% to $1.5bn - as lower profits in Networks and Content were offset by lower losses in Direct-to-Consumer.

Notably Linear Networks - which includes the likes of ABC, ESPN and Star, and accounts for $7.7bn of revenue, reported a 2% rise in revenues and just a 4% decline in operating profit. That reflects increased political advertising and a shift in IPL games on the revenue side, while the increased cost of College Football Playoff, NBA and IPL content impacted margins.

The picture in Parks, Experiences and Products remains tough, with sales down 53% as parks and cruise liners remain closed or operating at reduced capacity. Operating profits in the division fell from $2.5bn a year ago to a $119m loss, despite a modest uptick in consumer goods sales.

The group reported a free cash outflow in the quarter of $685m, compared to a $292m inflow last year. Net debt of $41.2bn represents a modest increase on the $40.7bn reported last year.

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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.