Shares of the Walt Disney Company (NYSE:DIS) rose after the broadcaster reported better-than-expected earnings for FQ4’23 and the company issued an upbeat forecast for 2024 free cash flow. The broadcaster also announced it will focus on more aggressive cost savings, raising its cost-cutting target from $5.5 billion to $7.5 billion, and Disney also reported an increase in Disney+ subscribers in 3Q23 . While I believe the subscriber growth and free cash flow guidance were particularly valuable, narrowing losses in the streaming segment suggest that Disney is moving closer to operating income profitability in the near term. If Disney can continue on this trajectory, I believe investors could be in for an epic valuation recovery!
I rated (and upgraded) Disney stock from hold to buy in August: Approaching an inflection Point (Rating Improvement). As a reason for the upgrade, I cited subscription plan price increases that were put in place to drive the company’s direct-to-consumer business. Disney’s subscriber growth in FQ4’23, a strong free cash outlook and much more aggressive cost guidance for FY2024 are why I’m upgrading Disney stock to Strong Buy.
Disney beat earnings estimates
Disney reported adjusted earnings of $0.82 per share, beating the average earnings forecast of $0.71 per share for FQ4’23 by $0.11 per share. Disney missed a bit on the top line with actual revenue coming in at $21.24 billion, but it was a very impressive overall earnings release.
Disney experiences an increase in subscribers
Broadcast companies fared well in the last quarter, and softening inflation, as well as confidence in the economic outlook, are also likely to have been headwinds. Netflix added 8.8 million subscribers on its streaming platform in the third quarter, a stellar result that was driven in large part by the company’s efforts to crack down on the password-sharing tactic that many of Netflix’s subscribers used to avoid paying.
Disney also had a great quarter as the streaming firm added nearly 7 million Disney+ subscribers in FQ4’23, the majority of which, 6.4 million, came from its international business. The subscriber growth brought the total number of Disney+ subscribers to 150.2 million in the last quarter. Disney+ subscribers in the previous quarter, FQ3’23, grew by just 0.8 million, so the rebound has been quite significant and has been responsible, along with price increases, for an increase in DTC revenue and narrowing of losses from the broadcast.
Subscriber growth was a significant catalyst for Disney’s revenue, which rose 12% in the streaming segment to $5.0 billion in FQ4’23. Disney’s total revenue rose 5% year over year to $21.2 billion.
Due to the increase in subscribers as well as the increase in prices (the price for a Disney+ premium subscription increased 27% in the third quarter), Disney has been able to significantly narrow losses in the streaming segment. Disney’s direct-to-consumer segment reported a loss of $0.4 billion in FQ4’23, showing a material decline of $1.1 billion compared to the year-ago period.
Disney massively increases its cost savings target, free cash flow guidance is impressive
Disney’s earnings release for its fiscal fourth quarter contained a number of surprises, and a more focused approach to tackling inflated costs was one of them. Disney previously guided for $5.5 billion in cost savings as the company seeks to improve its profitability profile, particularly in its loss-making direct-to-consumer business. This cost target has now increased by $2.0 billion to $7.5 billion. The new cost target represents a 36% increase compared to the previous target and is mainly driven by a reduction in spending on new content.
In FY 2023, Disney generated $4.9 billion in free cash flow, showing 345% year-over-year growth, but the real takeaway from the earnings release was management’s commentary about its free cash flow expectations.
Along with a much more favorable cost outlook, Disney has said it projects “significant” growth in free cash flow in FY 2024 and expects to see an FCF level approaching pre-pandemic levels.
Disney generated $6.9 billion in free cash flow, on average, between FY 2015 and FY 2019, the years before the pandemic. A return to this level in FY 2024 implies a ~41% increase in free cash flow in the new fiscal year.
Disney stock is attractively valued considering the momentum that streaming firms generate at all levels of the business. Disney is currently expected by analysts to achieve EPS of $4.49 per share in FY 2024 and $5.43 per share next year, implying a year-over-year EPS growth rate of 21%. Netflix is projected to grow its earnings per share by 30% next year.
While Netflix is expected to grow its EPS faster, Disney stock is a real bargain, in my opinion, considering how drastically the business is growing and improving. Disney is currently valued at a forward P/E ratio of 16.3X compared to Netflix’s forward P/E of 28.4X. For Netflix, the fiscal year ends in December while the fiscal year for Disney ends in September. Netflix is expected to grow EPS 9 PP faster than Disney, but I don’t believe the difference justifies a 75% higher valuation factor.
Disney stock also trades ~20% below its average 1-year P/E ratio, so I believe DIS is an extremely compelling bet in the streaming market right now. If Disney were to trade at the same earnings multiple as Netflix, as it has in the past, then Disney would be valued at $154.
I believe that given Disney’s double digit EPS growth potential, DIS can easily be valued at 25X forward earnings, in my opinion, which implies a fair value of around $136 (54% revaluation potential).
Both companies have seen strong subscriber growth in the last quarter, but my pick in the streaming market would be Disney. The streaming company has a number of catalysts beyond growing its subscriber base, as it is guiding for massive free cash flow growth for FY 2024 and is set to achieve operating income profitability in DTC streaming.
Risks with Disney
The biggest risk with Disney is that the company fails to achieve operating income profitability in the streaming business. Considering that management just announced a big increase in its cost savings target, DTC reaching profitability is a very real possibility in FY 2024. What would change my mind about Disney is if the broadcaster saw negative subscriber growth in its core Disney+ segment.
Disney shares rose 6% after its third quarter results, and I believe the streaming company is on a good trajectory given its subscriber growth last quarter. In my view, achieving operating income in the important direct-to-consumer business will remain the most important point of change, not only for Disney, but also for the streaming firm’s stock. In my view, optimistic cost and cash flow guidance strongly improves the risk profile for Disney. Considering Disney faces the catalyst of positive operating income in DTC, expects massive FCF growth in FY 2024, and the business is cheap based on P/E, I believe Disney stock is ripe for an epic recovery!