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As Disney parks reopen 'you should start to see a return to earlier valuations': Analyst

Yahoo Finance's Alexis Christoforous and Brian Sozzi speak to Steve Cahall, Wells Fargo Analyst, about the future of Disney as parks begin to reopen. Cahall says there is "no better person" to run Disney, than Bob Chapek.

Video Transcript

BRIAN SOZZI: The magic will soon be back at the Magic Kingdom. Disney this week unveiled its plan to reopen Disney world in Florida starting in early July with all sorts of new restrictions. And it couldn't come soon enough. The parks and cruises business makes up more than a third of Disney's total revenue.

Let's talk about it with Steve Cahall, who covers Disney at Wells Fargo. Steve, I think a lot of investors-- and you can break this down for us-- I think a lot of investors think once these parks reopen, traffic gets back to normal, Disney stock on fire. But that may not necessarily be the case.

STEVE CAHALL: Yeah, I think that's right in terms of the way a lot of investors are thinking about it. There is a general belief, and I share it, that as parks reopen, you should start to see a return to prior valuations. Disney was trading around the 140s, even 150s because of the strength of Disney+ prior to the pandemic crisis.

And it's come down a lot because its film production is halted. There is uncertainty around sports. But first and foremost, because its parks, which are a meaningful driver of cash flow and earnings, are shut down.

What I would say is that some of the recent optimism around the parks reopening is a tough one to call. I think there's still a long way to go in terms of how we're going to deal with coronavirus. And there's maybe a bit of irony in the sense that the briefing around reopening the parks was done virtually. So people weren't quite yet comfortable enough to get back together to reopen the parks. But they're already talking about it.

So I do wonder if maybe as investors, we've gotten a little too optimistic about how smooth parks reopening is going to go nationwide.

ALEXIS CHRISTOFOROUS: Yeah, Steve, I mean, Disney already said when they reopen, it will only be at 50% capacity. So right away revenue is going to take a hit. It has to, just by definition of the fact that they have less people coming through the door. How long do you think it might take-- this is such an unknown, but how long might it take for attendance at these parks to go back to pre-pandemic levels?

STEVE CAHALL: Well, I think if you wanted to say pre-pandemic levels, then we're really talking about a vaccine. To have hundreds of thousands of people going in on a weekly basis, to operate at full capacity, and to have the types of experiences which often requires cast members and guests interacting, which requires really large crowding, long lines to get on the rides, fireworks in the evening-- again, with a sort of crowding event-- for that to happen, you really do need an immune community. And that's only through heard community or through vaccine.

So that's kind of the really stage four, stage five type of activity that we'll see. And then the question is where do we go from here to there, and how long does it take? If it turns out that reopening is a smooth process, then they can go at 20%, 30%, 50%, 60% sort of gradually. I think the big question is whether or not the entire country has a reopening that's more sort of fits and starts with localized hotspots.

So I think Disney is doing the right thing. They're taking a planned approach. They're going to see how it goes. But there's still a lot of uncertainty in this whole process.

BRIAN SOZZI: Steven, jumping off what Alexis just was talking about, if the parks are not-- they don't come roaring back, the media business, of course, is still under pressure, do you think we're looking at over the next 12 months Disney cuts its dividend?

STEVE CAHALL: Well, they've already taken some action on the dividend. And so to me, that's very emblematic of how the company is thinking about the business right now. To their credit, they are indicating that there is more uncertainty than they've faced maybe ever in their history.

Again, as I said, sports are kind of shut down. We'll see how those return and in what form. Their major tentpole motion picture production is halted. The theatrical industry is kind of in a state of crisis in terms of the ability for people to go back to theaters. And the parks business is shut down with plans to reopen, but it's a little unclear in what form or at what level of capacity.

So they are managing the company through a very, very uncertain time. I think they're very upfront about that. And I think they see the dividend as something that's important. But it's not going to be more important than managing and running the business.

ALEXIS CHRISTOFOROUS: What's the advertising pain going to be like for Disney? I mean, they are diversified, but they're very reliant on advertising as well. And you just mentioned sports. They've got ESPN-- no sports, no advertising. What's that going to mean for the company's bottom line going forward?

STEVE CAHALL: Yeah, I mean, certainly we're in an advertising recession. Now I would say that Disney is less exposed to advertising than most media peers. So their advertising is really ESPN and ABC. But ESPN has a lot more subscription revenue than they do advertising revenue. And then, of course, the film business, the parks business, the consumer product business, and Disney+-- those are not advertising services.

So overall, as a piece of revenue, it's not that big. But overall, across the media space, we're sort of modeling advertising down in the 20% to 30% range year-on-year for most of our companies. And Disney certainly is in the center of that as well.

ALEXIS CHRISTOFOROUS: I want to talk about your rating on this stock right now. You lowered your price target to $107 a share. Disney's trading at about $116 right now. And you also have an equal weight rating. Why not an underweight, Steve?

STEVE CAHALL: Yeah, and keep in mind this was a stock that was at $85 not so long ago. It was at $95 not so long ago. And it was at $122 not so long ago. So the beta, the market is certainly above average right now.

I'd say that in my personal opinion, when we wake up and the coronavirus cases are increasing, the market goes down. And when they're decreasing, the market goes up. And there is a lot of percentage points on that, certainly uncharacteristically high amount.

So we still think of Disney as a really high-quality company. They have very strong assets. There is a lot of long-term cash flows associated with the content they produce. And they've been able to monetize the consumer in a really unique way with global brand strength.

The flip side is all those things I mentioned about the idiosyncratic uncertainties. And the parks business faces above-average risk, because I think anything that's crowd-based in order to succeed is just above average at risk right now. So putting all that together, we kind of come out equal. And we think that in a normalized market environment, the stock is at about fair value.

BRIAN SOZZI: Steven, are you confident that the new Disney CEO, Bob Chapek, could successfully drive the company out of its current predicament?

STEVE CAHALL: Well, Bob was going to have his hands full whether he was head of parks or head of the company right now. And maybe those are one in the same job, given what's going on. So I think there's no better person to steward the company right now, given that parks is the greatest area of uncertainty.

Which you could certainly say about Bob Iger and the prior management team, is they have left the company in a fantastic place when it comes to content value and direct-to-consumer. So those strategies still have some follow through yet to come. But they're very well in place.

Parks is a business that has been doing phenomenally and is managing through this really unique time. So I think his appointment certainly makes a lot of sense for a lot of the tactics that they're going to need in their quiver right now.

BRIAN SOZZI: All right, let's leave it there. Steven Cahall, Wells Fargo Analyst, thanks for coming on. Have a great weekend.

STEVE CAHALL: Thank you. You too.

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