Disney shares tumble on light guidance. But here's why we're raising our price target

Published Tue, May 7 20243:06 PM EDT

The pullback in Disney shares Tuesday is overdone despite the Club holding reporting mixed fiscal 2024 second-quarter results. We like what we're seeing beneath the headline figures, which could make the sell-off a buying opportunity once the dust settles around the stock. Revenue in the January-to-March period was about flat year over year at $22.08 billion, a bit short of the $22.11 billion expected, according to analyst estimates compiled by LSEG. Adjusted earnings per share in the quarter jumped 30% to $1.21, beating the LSEG consensus forecast of $1.10 per share. Disney Why we own it: We value Disney for its best-in-class experiential entertainment Parks business, which has proven to have immense pricing power. We also believe in the upside that can be realized as management executes in cutting costs, and expanding profit margins as it streamlines its direct-to-consumer product offerings and explores additional ways to monetize the company's best-in-class content portfolio and finds new ways to monetize ESPN. Competitors: Comcast , Netflix , Warner Bros Discovery and Paramount Global Last buy: Aug. 28, 2023 Initiation: Sept. 21, 2021 Bottom line There were some puts and takes this quarter, but management remains on the right track. A stock down 10% after earnings usually implies the results and guidance were a train wreck. That's far from what we're seeing with Disney. Disney's cost-reduction efforts are humming along, pricing power appears to be resilient and the combined direct-to-consumer (DTC) streaming business is still expected to achieve profitability by the end of the fiscal year in September. In the second quarter, the combined business — Disney+, India's Disney+ Hotstar, Hulu and ESPN+ — saw losses of $18 million, far better than the $659 million loss in the year-ago period. Sure, the DTC business is set to see steeper losses in the current quarter — and that's clearly weighing on the stock Tuesday — but a rebound is expected in the July-to-September period. It all nets out to management raising their full-year earnings outlook. We also were pleased to see management step up and repurchase $1 billion worth of stock in the quarter, while reiterating plans to buyback $3 billion total by the end of fiscal 2024. There is no denying Tuesday's stock decline stings. But we're in a position to view the drop through a buyer's lens because we made two sales last month at higher prices. The first sale — on April 1 at $121.72 apiece — came after Disney swelled to 5% weighing in our portfolio, a level at which our discipline to trim usually kicks in. We further reduced our stake on April 15 at $114.25 per share following management's proxy fight win versus Nelson Peltz. We aren't stepping in right away, but this pullback feels excessive given the upward revision to earnings guidance and reaffirmation of sustained profitability for the DTC business once we get past the current quarter. In some ways, the reaction to Disney's quarter mirrors how Netflix 's earnings report in April was received. The stock dropped 9% in a single session, treaded water for a couple of weeks and is now only about 1% lower than where it was heading into that report. We wouldn't be surprised to see a similar dynamic playout with Disney as investors come to the realization that Disney's streaming platform will be a top player in the crowded field. In fact, speaking with CNBC on Tuesday, Disney CFO Hugh Johnston noted that while the company isn't seeing much trade down — its theme-park business remains strong, for example — the streaming unit may benefit from tightening consumer budgets as people look to consolidate streaming subscriptions to the best-of-breed services. We are raising our price target to $130 from $120 on the back of an improved full-year earnings outlook and the expectation that we're in the last quarter of DTC losses. However, we are maintaining our 2 rating as we look for shares to find support, acknowledging that the near-term DTC profit outlook is likely to cap upside for the time being. Looking ahead Disney's combined DTC business is still on the path to profitability by the end of fiscal 2024 in September — a target the company set out to reach years ago. However, the current quarter is murkier with weakness attributable to its streaming offering in India, known as Disney+ Hotstar, which is weighed down by seasonality in the country's sports calendar. As far as we're concerned, the more important part is management said a rebound in DTC profitability is expected in the following quarter, with further improvement in fiscal 2025. Disney's Experiences division — home to its theme parks, cruises and consumer products — is also expected to see profits pressured in the current quarter. Among the reasons management cited were timing issues, such as technology expenses and the date of Easter, as well as higher wages and some normalization of post-Covid demand. Nevertheless, year-over-year profitability in the segment is expected to "rebound significantly" in the fourth quarter, management said, which helps assuage concerns about the current period. The team also continues to expect cost takeout to exceed $7.5 billion on an annualized basis by the end of the fiscal year and generate over $8 billion in free cash flow in fiscal 2024. More positively, management is now targeting full-year earnings growth of 25% year over year, up from 20% previously. Considering 2023 earnings of $3.76 per share, Disney's updated guidance implies earnings of about $4.70 per share, a penny short of Wall Street expectations. Quarterly commentary Entertainment Results in the Entertainment segment were mixed. However, the good outweighs the bad as the direct-to-consumer part of the segment — the main focus for investors — saw better-than-expected sales and a surprise profit across Disney+ and Hulu. DTC profitability benefited from Disney+ core subscriber growth, higher retail subscription prices, increased advertising revenue on the back of higher impressions, and lower distribution costs. Disney+ core — which excludes Disney+ Hotstar in India — subscribers increased by over 6 million with core average revenue per user (ARPU) increasing by 44 cents sequentially, as a 15-cent decline domestically was more than offset by a 75-cent increase internationally. Hulu Live TV benefited from increased pricing and subscriber growth. DTC is expected to report a loss in the current quarter, with no core subscriber growth being realized. However, it is expected to return to profitability and see subscribers increase in the fourth quarter. On the call, management called out several profit levers it has to work with to ultimately reach its DTC profitability goals, including increasing engagement through bundling, enhancing the programming catalog with some ESPN-related content, cracking down on password sharing and reducing distribution costs. Domestic and International Linear Networks profitability — basically the traditional cable TV business — was hampered by lower affiliate revenue because of subscriber declines. Domestic profitability also was also by a decrease in advertising revenue because of lower impressions due to lower viewership rates. Sports ESPN+ saw a 2% sequential decline in paid subscriptions, but that was partially offset by a 3% increase in average monthly revenue per subscriber. The sports streaming service has yet to reach profitability. Domestically, ESPN profitability was dinged by higher College Football Playoff costs due to the airing of an additional game versus the year-ago period and lower affiliate revenue tied to declining subscribers. Domestic ESPN advertising revenue was helped by higher rates, which benefited from that additional CFP game and an extra National Football League playoff game versus the year-ago period. An encouraging nugget on the call: ESPN was off to a strong start in the current quarter, with total day viewership numbers hitting their highest April result since April 2012 and primetime viewership reaching a new April month record. Clearly, Disney still has a big opportunity in sports as they execute on their DTC streaming strategy for ESPN. Experiences Despite better-than-expected revenue of $8.39 billion, operating income in the segment fell short of estimates. That mismatch indicates margin pressure for the theme park, cruise line and consumer products business. Domestically, profitability benefited from strength at Walt Disney World Resort in Florida and Disney Cruise Line, though that was partially offset by lower results at Disneyland Resort in California. All three benefited from higher ticket prices, though this was partially offset by increased costs such as wages. Internationally, operating results were driven by strength at Hong Kong Disneyland Resort thanks to higher ticket prices and increased spending on food, beverages, and merchandise. Attendance and occupancy room rates were also up during the period. (Jim Cramer's Charitable Trust is long DIS. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. 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The atmosphere at the Disney Bundle Celebrating National Streaming Day at The Row in Los Angeles on May 19, 2022.

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