Disney stock is down 19% from its 52-week high. This may scare investors away from the stock. But investors should look at Disney’s drop as a good buying opportunity.

At one point a few years back, Disney was one of the market’s most beloved growth stocks. It had raced so high that it became overvalued, and unappealing.

Walt Disney Co (DIS)

Thanks to its share price decline however, Disney stock’s valuation and dividend yield have come back to its historical average since 2000.

The company is currently ranked as a ‘Buy’ and Top 10 dividend stock using The 8 Rules of Dividend Investing.

It appears the market is concerned about Disney’s cable television business, and in particular ESPN. On the other hand, the overall company continues to grow at a high rate, thanks to exceptional growth in its other businesses.

This growth means the company is still generating strong returns for shareholders. As a result, this could be a good time to buy Disney stock.

Disney – Business Overview

Disney is a global media giant. It operates in five operating segments:

  • Media Networks (42% of sales)
  • Parks and Resorts (31% of sales)
  • Studio Entertainment (17% of sales)
  • Consumer Products & Interactive Media (10% of sales)

The Media Networks business houses Disney’s various television and cable properties, which include ESPN, the Disney Channels, and ABC.

The Parks and Resorts segment includes Disney’s theme parks, resorts, hotels, and its cruise line.

The Studio Entertainment segment includes the Walt Disney, Marvel, LucasFilm, and Pixar movie studios.

Lastly, the Consumer Products & Interactive Media operations involve production of a wide range of merchandise, such as toys, apps, books, games, and more.

Overall, the business climate remains strong. There is concern for Disney’s television and cable networks, but the business is still growing.

Revenue in the Media Networks business declined 3% last quarter, due to a 7% decline in the cable networks. This was in part attributable to lower revenues from affiliate fees and advertising, along with higher programming and production costs.

However, this was more than offset by strong results across the business. Revenue from Parks and Resorts rose 5% last year.

The best performance came from the Studio Entertainment business, which posted a 28% revenue increase in fiscal 2016. Disney benefited from several strong movie releases over the past year, especially Star Wars: The Force Awakens, which exceeded $2 billion in global box office sales last fiscal year.

Last year, Disney’s revenue grew 6% while its earnings-per-share rose 15%.

Free cash flow came to $8.44 billion last year, a 27% increase from the previous year.

Going forward, investors can expect Disney to continue growing earnings-per-share and free cash flow. The company has several growth catalysts set for the following year and beyond.

Growth Prospects

Disney’s growth prospects going forward are very good. Each of its business units has a compelling growth story.

In the Media Networks business, while ESPN is grappling with falling subscribers in the U.S., it still has a fundamental advantage in live sports.

ESPN is the dominant brand in live sports programming. This insulates the property against “cord-cutting”, the consumer trend of cutting high-priced cable packages in favor of skinnier bundles and streaming options.

While there are many networks that may suffer greatly from cord-cutting, ESPN is likely to remain standing for a long time to come. Consumers have taken a shine to streaming, but they still demand live sports.

This should propel higher affiliate fees for ESPN, which is its competitive advantage.

Elsewhere, Disney should benefit from continued growth in its Parks and Resorts. The consumer is becoming healthier financially, several years out from the Great Recession. Per-capita guest spending rose 7% last quarter.

And, the company just opened Shanghai Disney Resort. The park is a huge success thus far: it welcomed four million guests through the first four months of operation. It represents a major push into China for Disney, which is a key growth market going forward.

The Studio Entertainment business should continue releasing plenty of hit movies. This business segment is likely to hit $10 billion in annual revenue by itself. There will likely be plenty of movies from the Lucasfilm, Pixar, and Marvel franchises for years to come.

For example, in fiscal 2018 Disney is set to release four new Marvel movies, three animated films from Pixar and Disney Animation, and two Star Wars releases.

It has a diversified business model that fuels its strong growth. These businesses complement each other well.

The success of the studio business naturally benefits the consumer products and media businesses as well. For example, when a new Star Wars film is released, it creates a windfall in related merchandise sales.

Disney’s growth potential means is compelling. The company should continue growing free cash flow, which fuels its dividend growth and share repurchases.

Future Expected Returns

Disney stock currently trades for a price-to-earnings ratio of 17. This is significantly below the average; the S&P 500 Index trades for a price-to-earnings ratio of 25.

Disney stock is right around its own historical average. Since 2000, the stock traded for an average price-to-earnings ratio of 16.

Disney stock appears fairly valued. That being said, it can still generate high returns to shareholders. Future returns could be comprised of the following:

  • 7%-9% revenue growth
  • 3% share repurchases
  • 1% margin improvements
  • 2% dividend yield

It is not unreasonable to suggest Disney’s revenue growth could accelerate slightly from last year’s growth rate.

In addition, Disney aggressively buys back stock. Thanks to its high free cash flow generation, Disney spent $7.5 billion last fiscal year to buy back its own stock.

As a result, Disney stock could generate 13%-15% returns each year moving forward.  These are exceptional returns in today’s low interest rate environment.

Final Thoughts

Disney stock has not performed well over the past year, as the market is becoming more cautious over the company’s cable networks.

However, investors selling the stock are missing the bigger picture. Disney has several growth catalysts which should offset any continued weakness at ESPN.

Disney’s share price decline is a welcome buying opportunity. For most of the past two years, Disney stock appeared considerably overvalued. But at its reduced valuation level, the stock should generate strong returns from here.

Disney has a very bright future ahead. The stock is a great choice for long-term investors.

Article by Bob Ciura