For now, investors are throwing the baby out with the bathwater. Disney is an impressive business, with broad diversification, expected to grow consistently over the medium-term by somewhere around 10%-15%, and right now selling at a bargain price.
This is a strong investment opportunity. Here’s why:
Investors Are In Panic Mode
Warren Buffett reminds us that "people get smarter but they don’t get wiser. You can teach all you want to them… but when they’re scared, they’re scared." Indeed, right now investors are first selling, then asking questions.
At the forefront of investors mind are attempts to figure out just how big coronavirus’ implications will have on the economy, plus a lot of fear over just how cheap companies are likely to get. In other words, there’s a certain amount of logical economical reaction, plus a lot of fear.
Further compounding troubles for Disney’s shareholders, are investors' attempts to quantify Disneyland closures in Shanghai, Hong Kong, and Tokyo. And furthermore, whether Disneyland will have to close Parks at other locations too.
Disney For The Long-Term
Disney’s balance sheet carries a net debt position of $38 billion. However, when Disney is not aggressively investing into its direct-to-consumer business, it has generated close to $8 billion of free cash flows (not earnings, but clean free cash flow). Hence, its balance sheet is strong and affords Disney plenty of flexibility.
Having said that, close to half of Disney’s operating income is generated from its Parks, Experiences and Products segment. Consequently, considering the Parks closed so far and the potential closure of others will have a substantial effect on Disney’s near-term overall profitability.
However, readers should remember Disney is more than just its Parks.
A Very Promising Direct-to-Consumer Operation
A substantial amount of Disney’s operating profits is derived from its its Media Networks segment -- close to 40% of its total operating income. Indeed, the argument could be made that as people embrace "social distancing" on the back of this outbreak, households may increase their viewership of Disney, ESP, and ABC. This once again reinforces just how well positioned Disney finds itself.
However, the crown jewel from Disney has to be its investment into growing its Disney Plus operations. Although only launched in November 2019, Disney+’s most recently reported figures were 28.6 million domestic paid subscribers. In other words, there is very strong consumer appetite for Disney+.
Valuation - Large Margin of Safety
2020 is not going to a highly profitable year for Disney.
Firstly, Parks closures will weigh on its results. Secondly and more importantly, Disney is aggressively investing huge sums into its direct-to-consumer platform.
Having said that, both these effects are temporary in nature and Disney's spending should revert to normality over the coming twelve to eighteen months.
Realistically, in a normalized environment, Disney’s top line is likely to continue growing at approximately 10%-15%. Given that in a normal year Disney’s cash flows from operations reach close to $14 billion and are expected to grow, investors should minimally be willing to put a 20x multiple to its trailing normalized cash flows, valuing its market cap much closer to $280 billion.
The Bottom Line
Disney is very well diversified, growing its operations at a steady clip while generating strong cash flows.
For now, this investment is trading very cheaply, but when investors’ calm returns, investors will rapidly reprice this investment higher.