Disney Disappoints and I Want Out: Here’s how to trade it in now

Disney Disappoints and I Want Out: Here’s how to trade it in now

On Tuesday afternoon, The Walt Disney Company ( DIS ) released the company’s fourth quarter financial results. To say that Disney had an absolutely awful quarter would be an understatement.

For the three-month period ended Oct. 1, Disney posted adjusted EPS of $0.30 (GAAP EPS: $0.09) on revenue of $20.15 billion. The adjusted bottom line number (-19% YoY) badly missed expectations by around $0.55, while the top-line print (+8.7% YoY) missed Wall Street’s consensus view by well over $1.25 billion $. Ugly.

The numbers on the line fail to impress. Total segment operating income rose 1% to $1.597 billion, while net income rose 1% to $162 million. Cash flow from operations shrank 4% to $2.524 billion, while free cash flow shrank 10% to $1.376 billion. All as costs and expenses rose 9.3% to $19.608 billion.

The crucial thing? It comes from heavy investment in emerging businesses and a slowdown in advertising. The bright spot was in the parks, but as we see, the parks cannot carry the entire brand. Leadership here either needs to evolve to changing economic conditions or get out of the way. The stock traded significantly lower overnight.

Department performance

Disney Media and Entertainment Distribution drove revenue of $12.725 billion (-3%), generating operating income of $83 million (-91%). Both of those numbers fell short of Wall Street expectations.

Linear Networks led to revenue of $6.335 billion (-5%), generating operating income of $1.735 billion (+6%). Revenue missed here, but operating income beat expectations.

Direct to the Consumer drove revenue of $4.907 billion (+8%), generating operating income of -$1.474 billion (down from -$630 million). Both of these numbers fell short of expectations. There was good news… Disney+ ended the quarter with 164.2 million subscribers, up 12.1 million. This exceeded expectations. However, Disney+’s global ARPU (average revenue per user) fell 5% to $3.91, which missed consensus by a lot.

Content Sales/Licensing and more drove revenue of $1.736 billion (-3%), generating operating income of -$178 million (down from -$65 million). This segment, like the DTC, was lost on both lines.

Disney Parks, Experiences and Products drove revenue of $7.425 billion (+36%), generating operating income of $1.514 billion (+137%). Here again, both of these numbers fall short of consensus.

-“Domestic” led revenue of $5.01 billion (+44%), generating operating income of $741 million (+204%). Hurricane Ian shows up as a $65 million negative impact on operating income here.

-“International” led revenue of $1.074 billion (+55%), generating operating income of $74 million (from -$222 million).

Consumer products drove revenue of $1.341 billion (+4%), generating operating income of $699 million (+13%). This business truly exceeded expectations.

Directive

Disney did not provide any guidance in the press release. On the call, CFO Christine McCarthy provided a loose outlook for fiscal 2023. Assuming no “material change in macroeconomic sentiment, the company expects both full-year revenue and segment operating income to grow in the high single digits percentage against the fiscal the year has just ended”. (Wall Street was looking for projected revenue growth of about 12.5%).

McCarty then made some comments about looking forward to the next 100 years as opportunity transforms the business. This comment, after a quarter like this, after such guidance… went over like a lead balloon.

McCarty also reported that cash spent on content will increase from $30 billion in 2022, while CapEx will increase from $5 billion in 2022 to $6.7 billion. Better hope that no substantial change in macroeconomic sentiment occurs. The yield spread between the US 10-year Treasury note and the US 3-month note suggests that economic winter is approaching.

Balance sheet

Disney ended the quarter with a net cash position of $11.615 billion and inventories of $1.742 billion. This left current assets at $29.098 billion (-13.6% YoY). Current liabilities amount to $29.073 billion. That leaves Disney’s current ratio at a barely acceptable 1.0. The company’s quick ratio is 0.94, which doesn’t excite me. Twelve months ago, Disney ran a quick ratio of 1.04. There has been some notable deterioration in the quality of this balance sheet.

Total assets are $203,631 billion, including “goodwill” and other intangibles of $92,794 billion. This is 45.6% of the total assets. While I’m uncomfortable with such a high percentage of assets being classified as intangible, it would be difficult to really put a dollar amount on Disney’s brand and public position across multiple businesses.

Total liabilities minus equity amount to $104,752 billion. This includes $45,299 in long-term borrowing. That debt is down from a year ago, but a lot of work needs to be done to bring the debt more in line with the cash position. The best I can say about this balance sheet is that it’s not a disaster. That doesn’t make it a fortress at all.

Wall Street

Since these earnings were released late Tuesday, I’ve noticed nine sell-side analysts rated four stars or better on TipRanks who have opined on DIS. Among the nine analysts, there are seven “buy” or buy-equivalent ratings and two “hold” or equivalent ratings. The average price target among the nine is $116.33, with a high of $135 (JP Morgan’s Philip Cusick) and a low of $94 (Doug Creutz of Cowen & Co).

Skipping the high and low as possible outliers doesn’t move the needle much. The average price target among the other seven analysts is $116.86.

My thoughts

Performance for the quarter was a huge disappointment. The guidance was not very helpful and what we heard was also disappointing. The balance sheet is not as strong as it was just a year ago. Direct to Consumer needs to improve in terms of achieving profitability faster than it is. Linear Networks needs to slow its descent. Even trading at an $88 handle, down 11% this morning, the stock trades at 18 times forward earnings, so it’s not cheap here.

The worry is that it’s hard to see any improvement going forward for long as things stand. The call was almost an embarrassment, as if management has no idea that their performance is and was anything but completely unacceptable.

DIS is now falling to the $80 highs testing both the July lows and the central trendline of the retracement pattern. Relative strength is weakening as the stock’s daily MACD undergoes a bearish cross of the 26-day EMA from the 12-day EMA. The stock is now trading 14.5% off its 21-day EMA and 25.6% off its 50-day SMA.

I’m long these shares at an average price of $92.54, so I’m not experiencing much pain at this point, but this position was a nice winner earlier this week.

Do I want to leave Disney? At this point I do. Does it make sense to sell the shares here? No. I will probably trade these stocks for the rest of the week and try to recoup my 4% loss.

However, if I wanted to get out right now, it would make more sense to write December 23rd $89 calls to the position for about $5. This way, if the trader pulls out, the exit price improves from $89 to a net $94. If the trader does not withdraw. Then said trader pockets the five bucks and still has to ride out a drop in equity position.

Get an email alert every time I write a real money article. Click “+Follow” next to my byline in this article.

Leave a Reply

Your email address will not be published. Required fields are marked *