Some have doubted The Walt Disney Company (DIS -0.64%) in recent years, but there's no doubt that it still has the magic touch when it comes to making content. Pixar film Inside Out 2 is Disney's latest home run. It's the highest-grossing film of 2024, a smashing success by every metric.
The impact of its popularity will trickle out to other parts of the business, such as its Disney+ streaming platform. And it shows that Disney's core growth engine remains intact despite the stock's poor performance. The shares are down nearly 30% over the past five years.
So, should investors view the success of Inside Out 2 as a green light to buy shares? Not so fast. Disney has some core challenges that could continue pressuring the stock.
Disney has definite long-term potential
Disney remains an iconic brand and a fantastic business. With a history that goes back generations, it is today arguably the world's most powerful branding machine, with a stacked intellectual property portfolio that it monetizes through film, television, amusement parks, cruises, merchandise, and streaming. Nobody bats a thousand -- not even Disney can produce smash hits every time. However, Inside Out 2 demonstrates that Disney can still knock it out of the park.
The company has spent a lot of time and money building out its streaming business, which includes Disney+, Hulu, and ESPN+. Total paid subscriptions for Disney+ and Hulu have topped 167 million worldwide (excluding its Hotstar service in India), even though Disney+ only launched in late 2019. That massive streaming business will soon turn profitable; it generated just $18 million in operating losses in its fiscal 2024's second quarter (which ended March 30). That's a vast improvement from its $659 million loss in the prior-year period.
This momentum has made analysts bullish about Disney's earnings. Wall Street's long-term estimates call for annualized earnings growth to average nearly 17% for the next three to five years. That makes the stock a potential deal trading at a forward P/E of 21. So, given all these positives, why should investors hesitate to buy it?
Addressing two major problems
In my view, Disney has two major fundamental problems that need solving.
First, the company invested heavily in building its streaming service. In 2019, Disney spent $71 billion acquiring most of the content owned by Fox. This ultimately gave Disney enough assets to make Disney+ successful. However, the acquisition significantly encumbered Disney's balance sheet. To start addressing that, management cut the dividend and halted share repurchases.
While Disney has slowly made progress in paying down its debt, its leverage remains above 4 times EBITDA today. That's not a high enough debt level to prevent major credit bureaus from awarding Disney an investment-grade credit rating, but it weighs on the business and limits management's flexibility.
DIS Total Long Term Debt (Quarterly) data by YCharts.
Second, and more concerning, is Disney's inability to secure long-term leadership at the top. Bob Iger is highly respected, but he's 73 today. He retired from the CEO role in 2020, but his successor, Bob Chapek, didn't impress and was ultimately pushed out in 2022, at which time Iger returned. He plans to retire again when his current contract with Disney expires in 2026.
Disney's business model is simple in theory: Create and monetize great content. However, the company itself is complex. Running a movie studio is entirely different from running an amusement park chain or a cruise line. Additionally, Disney's wide cultural presence makes it susceptible to political crossfire that requires skill to navigate peacefully. One could argue that Chapek's brief tenure underlines how important quality management is to getting the business to perform to its full potential.
What should investors consider doing?
Disney remains a blue chip company despite the stock's rough five-year stretch. The streaming business has grown significantly enough that it should give a material boost to Disney's earnings growth as it turns profitable. I can see why the shares look appealing based on the growth that analysts expect in the coming years, but I still believe investors should take a cautious approach.
Based on the struggles of other consumer discretionary companies, consumers seem to be tightening their wallets lately, which could negatively impact the results from Disney's parks and cruise lines segment, its biggest profit contributor. The company's balance sheet could become more problematic if a slowing economy hampers Disney's business. And the question of who will lead the company next could remain unanswered for a while longer, so investors will also need to get comfortable with uncertainty on that score.
With all that in mind, those who choose to invest in Disney now should consider building their positions slowly while keeping an eye on how the business holds up over the coming quarters.
