To The Moon

Summary

• Walt Disney's share price is miles away from its 52-week high, and I believe that there is greater room to fall.
• While Walt Disney is a great company, they have many challenges ahead of them, and it's not certain whether they can be overcome.
• I initiate coverage on Walt Disney using a simple 5-year EPS projection, and have arrived at a 'Hold' rating based on my estimated valuation.

Walt Disney (NYSE:DIS) stock currently trades at about $133 (at the time of writing this article), which is a drop of over 30% from its 52-week high of $203.02. While many investors may be pouring in to buy the dip, I would be extremely cautious with such an investment, as I believe that the company has multiple hurdles to cross before such a valuation can be justified. In this article, I will be explaining my concerns with regard to Walt Disney's prospects, and justifying, with a simple 5-year EPS projection, that Walt Disney's stock is still overvalued today.

A rally that went too far

For the most of 2021, Walt Disney's stock has been trading between $160 and $200, with a high of $203.02. Comparatively, the stock was only trading in the $110-$120 range in late 2020. This, however, changed significantly once positive news regarding Disney+ was announced. Very much like Netflix (NFLX), Disney+ is a streaming platform that offers various movies and TV shows upon subscription. Once the platform was formally introduced, there was a huge change in investor sentiment. With people being increasingly bullish on the added source of revenue from Disney+, and also the potential financial gains once theme parks recover from the pandemic hit, Walt Disney's share price saw a steep upward trend. There was even arecord day where the share price rose by a whopping 14%. This was the beginning of the huge rally in Walt Disney's stock.

The eventual fall

The rally came to an end eventually, with the share price breaking below $150 late last year. Today, the company trades at about $133 a share, a price point that not many in the past would have imagined considering the previously strong and seemingly unbreakable upward trajectory. Yet, despite the huge fall, I still do not think that the current valuation is justified, and have serious reservations about the company's prospects. In the following points, I will be listing some concerns which have to be addressed before considering an investment in Walt Disney stock.

Disney+ subscriber growth

While the introduction of Disney+ took the world by storm, evenWalt Disney themselves have admitted that they could be facing a decline in subscriber growth. While I have to concede that themost recent quarterwas a very successful one, with an increase of 11.8 million paying users, this same metric in the previous quarter was significantly lower - to be exact, it was 2.1 million. The sudden surge in the previous quarter could be related to the holiday season, where families generally stayed in to watch more shows after a year of hard work. In addition, there could have been a seasonal increase in demand for Christmas-related films. Either way, whether Disney+ is able to keep up a consistent growth rate in subscribers remains a question to be answered. The problem intensifies when you consider the competition from popular streaming platforms like Netflix.

Project delays

One of Walt Disney's newest projects includes a cruise ship by the name ofDisney Wish. Disney Cruise Line intended to offer its voyage services through Disney Wish by 9th June 2022, but this has now beendelayed to 14th July 2022. The company has offered a 50% discount to all affected guests to make up for their delay. While this may just be a month's delay, it does raise questions about the company's efficiency and capabilities when it comes to introducing new products and services. The disappointment among the community of previously-excited customers may hurt Walt Disney's revenue numbers, and could also damage the overall sentiment towards the company's offerings.

Worrying financials

Walt Disney is a company that boasts very healthy revenue growth. Its most recent gross profit margin was also decent. However, while there are many reasons to be positive about Walt Disney's financials, there are a few concerning metrics which we cannot ignore.

Free cash flow

As of Walt Disney's2021 annual report, free cash flow has seen a decrease of 44.69%, dropping to $1.99 billion from a much higher $3.59 billion in the previous year. This is not necessarily a bad thing, considering Walt Disney may be using more funds to invest in its growth, but the magnitude of this decrease does indeed raise eyebrows. It remains a question whether Walt Disney is able to sustain a healthy free cash flow growth rate in the long term.

Shares outstanding

According topast year financials, diluted shares outstanding have increased over the years. From just about 1.51 billion in the annual report of 2018, the number currently stands at 1.83 billion, as of 2021's annual report. While issuing shares is a good way to generate cash flows, it also hurts shareholders by reducing their stake ownership. As a result, while Walt Disney may benefit from being able to fund their operations and initiatives, shareholders would experience dilution. This may have a negative impact on the share price, especially if earnings do not offset the increase in shares outstanding.

Free cash flow to long term debt ratio

This ratio reflects how easily a company can pay off its debt, and is also a good indication of its financial health. This metric, as of 2021's annual report, is an astonishing 0.038, compared to a desired value of 1 and above. The company is taking on a huge amount of debt, with $51.77 billion in long-term debt and just $1.99 billion in free cash flow. While debt financing is a good method for Walt Disney to fund its operations without compromising any control over the business, it cannot be understated that Walt Disney is a far cry from paying off the massive amount of debt it has taken on. This could mean financial trouble for the company in the long term.

Profitability

Parks, experiences and products generated about $16.5 billion in revenue in 2021, with the segment's operating income standing at $471 million. This is a far cry from the same two metrics in 2019, which were $26.2 billion and $6.7 billion respectively. Another thing to consider is the profitability of Walt Disney's DTC (direct-to-consumer) services like Disney+. While DTC has accounted for $16.3 billion in revenue as of 2021, the same segment also faces an operating loss of about $1.7 billion. Profitability is a significant concern worth considering here, and it's not certain whether future revenues can sufficiently offset the costs.

Walt Disney Stock valuation

This is where I'd normally estimate a fair share price of Walt Disney's stock using a stock valuation method. For the sake of this article, I'll take a slightly different approach - I'll be using a simple EPS forecasting model to show that even with extremely optimistic assumptions, this stock is still not a buy at its current valuation.

Metrics

Metrics used(Prepared by author)

Let's briefly go over the metrics I will be using in this model.

Shares outstanding

For shares outstanding, I've gone for an average annual increase of 1% over the next 5 years, which is consistent with the company's history of issuing shares. Considering that the (diluted) shares outstanding has seen a net 32% increase in less than 5 years (1.51 billion in 2018 to 1.83 billion in 2021), this is already a fairly optimistic estimate.

Projected annual growth rate

I have projected an average annual growth rate (in earnings) of 20% over the next 5 years, which represents a very positive outlook that can definitely only be fulfilled if the company manages to bounce back strongly from the pandemic hit. This is currently extremely unclear given the company's current financial situation.

Projected P/E

I have projected a P/E (TTM) of 79.44, which is the company's P/E at the time of writing this article.

Minimum annual rate of return

This metric describes the desired average annual rate of return, over a period of 5 years, for investing in Walt Disney stock. I have used a modest 10% for this metric, which is just slightly above the return you'd expect to earn from investing in a good ETF. Ideally, you'd want to go higher so that you can beat the market by a decent margin.

Margin of safety

For the sake of this optimistic analysis, I will not be introducing any margin of safety.

Valuation based on optimistic assumptions

5-year projection based on assumptions(Prepared by author)

We have arrived at an estimated share price of $129.63, which is below the current share price of about $133. Do note that this is not my actual price target as the assumptions applied in this model are very optimistic. I've used this to illustrate that even for such overly-positive assumptions, today's price is still too high. In addition, a share price of $129.63 would give you an annual return similar to a good ETF likeSPDR S&P 500 Trust ETF(SPY), which bears significantly less risk compared to investing in Walt Disney. There is simply too much risk for too little reward at today's valuation.

Price target

Personally, I'd tag on a 30% margin of safety to my previous model. This is to account for anything that could go in the opposite way of my initial assumptions. Given the nature of this investment and my personal risk tolerance, I believe that 30% is a sufficient margin of safety. This will give a price target of $90.74 a share, which is a reasonable point of entry for me.

Conclusion

Let me be clear: I do not think that Walt Disney is a poor company by any means. They're a huge business with multiple sources of revenue, and the recent introduction of Disney+ has definitely taken the world by storm. There's a good chance that we will see a healthy recovery in the other aspects of the business that have been hit by the pandemic. I would personally wait for these things to play out before making a concrete decision with regard to this stock, as the risk-to-reward ratio isn't in my favour at today's valuation. I will conclude my analysis with a 'Hold' rating and a price target of $90.74 for Walt Disney stock.

Source: Seeking Alpha