Disney (DIS) released its December quarter (fiscal Q1 2019) results this week, which were largely underwhelming. However, looking further into the end of 2019, Disney will release its highly anticipated Direct To Consumer platform. This report highlights both the good and the bad of its new offering and why ultimately, Disney is terrifically undervalued. The stock closed up 0.50% to $111.51 Friday.
The one thing going for Disney is that its Parks, Experiences & Consumer Products segment continues to be highly profitable, accounting for close to 60% of its total operating income. Moreover, it is the one business unit which appears to be posting double-digit operating income growth as of Q1 2019. Without this lucrative and growing business segment, Disney would be left in the impossible position of being too late to adapt to mounting challenge from Netflix (NFLX) .
Said another way, Disney's Park, Experiences & Consumer Products not only gives Disney the financial resources it needs to invest into its Direct To Consumer platform, but it also offers a nice amount of steady diversification to Disney. Now, onto the bad news.
Disney's Q1 2019 results were anything but stellar. Disney's top line was flat, and its EPS number was down 3% to $1.84. Also, its all-important free cash flow figure was meaningfully down by 28% to $904 million. More specifically, the main reason for the weak comparative results was due to a lackluster studio season, with the same period a year ago benefiting from record sales from Star Wars and Thor.
Nevertheless, investors were already largely expecting weak results and most investors continue to be uncertain how Disney's Direct To Consumer offering will play out. But uncertainty brings opportunity.
Direct To Consumer Service
Disney has been too slow to adapt to the very fast changing consumer appetite for home streaming. The challenger, Netflix, has one strong advantage too, which is that it doesn't have a long theatrical window. Disney, on the other hand, wishes to keep its theatrical window unchanged, which is unsurprising giving the huge revenues the movies generate for Disney.
However, what was for a long time a strong competitive advantage for Disney has now become its Achilles heel. Netflix continues to be more innovative and bolder with getting larger amounts of content in front of consumers quickly.
What's more, Disney has had to be frank and admit that its DTC platform will not only be hugely capital intensive, but that if it wishes to quickly ramp-up its content library, it will be forced to outsource its content.
This is a problem because there has never been a more expensive time to acquire scripted content. The competition in the space is red hot. There is Amazon Video (AMZN) , Apple (AAPL) and Netflix all competing for top-quality content, to name a few. Also, on the unscripted side of the equation, YouTube (GOOGL) also commands a large amount of screen time.
Ultimately, Disney Is Undervalued
In the above table, I have included Amazon, which is not a direct competitor to Disney on the retail or AWS side of its operations, but is on the Video platform. Also, it is important to appreciate just how much investors are willing to pay for the right content provider.
Additionally, similar comments can be made about Netflix. If there is the potential to post revenue growth of at least 20%, investors are more than happy to give a large multiple to sales (10x sales for Netflix's).
Whereas, in Disney's case, not only has the share price not gone anywhere in years, but we can clearly see in the table that Disney is presently undervalued, both on a P/cash flow from operations and on a P/Sales ratio. Specifically, we can see that Disney is both cheaper than its peers and cheaper than its own historical average -- a clear indication that Disney is currently undervalued.
Disney has a lot going for it in 2019. Its Direct To Consumer platform could be the medium-term to long-term growth opportunity that Disney needs to reignite its top-line growth. However, on balance right now, investors are not being asked to pay up for the likelihood that Disney succeeds in its top-priority strategic goal. That's why I believe that Disney is undervalued at just 12x P/cash flow from operations.