It’s probably unfair to Walt Disney Co (NYSE:DIS) to call Solo: A Star Wars Story a bomb. After all, the movie generated $103 million in its opening weekend — the fourth-best showing so far this year. And when including an estimated $65 million in overseas receipts, Solo at least looks set to be a profitable film for Disney.
But by all accounts, the weekend is quite a disappointment. The $103 million haul came in well below estimates. The film was a particular disappointment in China, as Bloomberg pointed out on Sunday. And the weakness is a reminder of just how precarious Disney’s position overall is at the moment — and how dependent it is on its franchise films.
DIS stock has been rangebound for over 3 years now, trading mostly around the $100 mark even as broad markets have moved nicely higher. And I’ve long argued that the underperformance makes sense. Disney is facing real challenges that threaten a substantial amount of its profits. And if the studio business falters at all, the company looks pretty much out of options.
Solo: A Star Wars Story Disappoints
The obvious question when it comes to the opening weekend numbers for Solo is whether Disney made a bad movie or whether audiences are suffering from “Star Wars fatigue”. Figures from Rotten Tomatoes suggest early reviews, at least from the audience side, are solid. A 62% Audience Score actually compares favorably to a 46% score for Star Wars:The Last Jedi, released back in December. (Critics were less positive on Solo, however.)
With a release date just five months after The Last Jedi, it’s possible that Disney simply pushed the movie too soon. But media observer Scott Mendelson argued that Solo simply wasn’t attractive enough on its own. Disney has pushed through Marvel releases in short timeframes and had huge success, notably with a blowout opening for Black Panther.
It’s probably better news for Disney if the answer is that Solo simply didn’t capture filmgoers’ imagination. Because the alternative suggests a significant problem for the company — and for Disney stock.
Disney’s Reliance on Franchises
The long-running problem for Disney stock has been the exposure of its ESPN unit to ‘cord-cutting’. 47% of fiscal 2017 profit came from its Media Networks (which also includes ABC and Freeform, among other properties), a figure that has dropped to about 40% in the first half of FY18. With subscribers dropping across the board, that represents a significant problem for DIS stock, as I wrote back in March.
Without a reversal in that business, the rest of Disney needs to pick up the slack. The parks business is performing exceedingly well, with operating profit up a sharp 24% so far this year. But Consumer Products (12% of FY18 segment-level profit) is in the throes of a multi-year decline.
And so over half of the company’s profits are coming from challenged businesses. That means the Studio business simply has to grow just to keep Disney’s profits intact. But film profits actually look relatively flat, declining in FY17 before a rebound in the first half of fiscal 2018.
And the obvious concern here is that the company’s strategy of focusing on franchises in its Marvel and Pixar units, along with Star Wars, will lead to audiences simply getting a bit tired. If that happens, Disney is in big trouble. Only the parks business — still less than 30% of profit YTD — will look truly attractive. And even a seemingly reasonable, if not cheap, 13x+ forward P/E multiple will be tough to hold.
The Value of DIS Stock
After all, media companies are priced for declines, or something close to it. CBS Corporation (NYSE:CBS) trades at less than 9x forward EPS, even though I think that stock is too cheap. Cable network operators AMC Networks Inc (NASDAQ:AMCX) and Discovery Communications Inc. (NASDAQ:DISCA) are even cheaper. Toy makers Hasbro, Inc. (NASDAQ:HAS) and Mattel, Inc. (NASDAQ:MAT) are down sharply over the past year.
The market doesn’t particularly like either the media or consumer products businesses right now — both at Disney and elsewhere. And that means either Studio has to grow, or more than two-thirds of Disney’s profits are coming from challenged, if not declining, businesses. That’s not a scenario that will allow DIS stock to break out of its range.
Indeed, it might even suggest that DIS could fall quite a bit. Something like 10-12x earnings would value the stock below $90 — at least 10% downside. That’s not an unreasonable multiple if the Studio business is done growing.
That’s not guaranteed, of course. Marvel has a ton of movies coming out over the next 12 months. A new Star Wars returns next year, with more on the way after that. If the weak performance of Solo is just a one-off issue, Parks could help Disney muddle through. But if it’s not, DIS stock has a real chance to test a multi-year low.
As of this writing, Vince Martin is long shares of AMC Networks Inc. He has no positions in any other securities mentioned.
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