Disney (DIS) reported slightly disappointing earnings for its 4Q21 with modest shortfalls across most business segments headlined by preannounced weak Disney+ streaming subscriber additions and poor operating margins at theme parks.  With a new fiscal year starting in October, management took the opportunity to reset expectations across most of its business lines. 

Stock Reaction:  Since DIS last reported quarterly earnings in August, the company indicated that it was seeing a slowdown in subscriber growth for its Disney+ streaming service.  This news came as a surprise to Northlake.  We previously expected continued strength in streaming and a rebound in theme parks as they fully reopened to allow the stock to break out of out of the $170-$200 range it had been in since early in 2021.  After reporting quarterly earnings yesterday, the stock did break out.  Unfortunately, it moved lower into the $160s based on the new FY22 expectations and falling investor confidence that Disney+ will meet the company’s multiyear growth targets.

Earnings Analysis:  The only material concern arising from the slight shortfall in the 4Q21 earnings was the weak operating margin at the company’s theme parks.  The sharp drop in the stock has much more to do with the new FY22 outlook.  Investors place little value on DIS’s traditional media businesses including ESPN, ABC, and local television stations.  The focus is squarely on theme parks and streaming.  Despite the shortfall in theme parks margins, the news for that segment is generally good.  Demand trends are strong and set to accelerate as the U.S. allows vaccinated international travelers to return.  In-park spending is well above pre-pandemic levels.  New ticket plans are proving popular and financially accretive.  Unfortunately, permanent cost savings are being offset by inflation in wages and other inputs.  Nonetheless, we still expect a return to at least prior margins despite the 4Q21 shortfall.  Theme parks should provide incremental value to DIS shareholders as the parks fully ramp over 2022 and especially 2023.  We have less confidence in the outlook for Disney+ after the new guidance calling for continued subdued growth in new subscribers until the second half of FY22 and increased spending on content above prior expectations.  Management notes that the timing of new country rollouts and new content is heavily weighted to late 2022 and 2023.  Disney+ is currently in 60 countries and could reach 160 by the end of 2023.  Content production delayed by the pandemic shutdowns should reach the desired level of one new original per week in the fall of 2023 across key intellectual property including Marvel, Star Wars, Disney, Pixar, and National Geographic.  Furthermore, local language production will soar into the hundreds, which is crucial as geographic reach of the service expands.

Target Price: We still expect Disney+ and the company’s other streaming services – especially Hulu – to be successful and drive value.  However, due to lower visibility of profits and delayed timing at Disney+, we are lowering the value we place on the company’s streaming services.  This reduces our target price from $225 to $205.  Following the sharp drop in the stock today, this still equates to upside of 25%.  The shares are unlikely to reach this level until there is renewed momentum for Disney+ subscriber growth and clear signs of the timing for theme parks to reach peak profit margins.  One near-term catalyst could be stronger subscriber growth in response to Disney+ Day taking place on November 12 when the company is offering a surge of new content.  It is also possible that DIS has reset expectations, giving investors all the bad news.  Often this type of kitchen-sink guidance sets up a bottom for a stock.  DIS has a great track record and arguably the best content in the world, so while frustrated by the loss of 2021 and much of 2022 for our investment thesis, we are willing to sit tight. 

DIS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.