Analysis: DIS NFLX

Walt Disney (DIS) reported after the closing bell on Thursday mixed results with its fiscal second-quarter earnings. Revenue of $15.61 billion (-18% YoY) fell short of the $15.613 billion estimate, but adjusted earnings per share of $0.79 (-48% YoY) were much better than the expected $0.27 per share.

"We're pleased to see more encouraging signs of recovery across our businesses, and we remain focused on ramping up our operations while also fueling long-term growth for the Company," Disney CEO Bob Chapek said in the press release.

"This is clearly reflected in the reopening of our theme parks and resorts, increased production at our studios, the continued success of our streaming services, and the expansion of our unrivaled portfolio of multiyear sports rights deals for ESPN and ESPN+."

Disney reports its operations in two segments. The first is Disney Media and Entertainment Distribution (DMED), which contains Linear Networks, Direct-to-Consumer, Content Sales/Licensing and Other. The second is Disney Parks, Experiences, and Products (DPEP). 

Let's start with media and entertainment. 

Adding Up Ad Revenue, Subs

Linear Networks revenue was $6.746 billion (-4% YoY), missing estimates of $6.935 billion, while operating income was $2.849 billion (+15% YoY) was higher than estimates of $2.404 billion.

Domestic Channels revenue was $5.418 billion (-4% YoY) while operating income was $2.281 billion (+12% YoY). Operating income was higher, thanks to increases at Disney's Cable and Broadcasting businesses. Cable's income was up, thanks to lower programming and production costs and higher affiliate revenue, partially offset by lower advertising revenues, which fell due to lower average viewership. Meanwhile, Broadcasting profits increased thanks to growth at ABC, where income was higher because of lower programming and production costs and higher affiliate revenue, partially offset by lower advertising revenue.

This is somewhat disappointing to see advertising revenues continue as a drag, but it should come as a surprise to no one, and remember, Disney's pivot to streaming should alleviate those concerns.

International Channels revenue was $1.328 billion (-4% YoY) and operating income was $348 million (+27%% YoY). Driving the increase in operating income was lower programming and production costs and an increase in advertising revenues, partially offset by lower affiliate revenue. Programming and production costs were lower because Disney is allocating more new content on the Disney+ to support its launch in new markets. Ad revenue was higher, thanks to an increase in average viewership.

Direct-to-Consumer revenue of $3.999 billion (+59% YoY) missed estimates of $4.048 billion, even though the operating loss of $290 million was smaller than estimates of $672 million. Disney continues to post smaller-than-expected losses at direct to consumer, however, management was not ready to move forward the profitability timeline when asked on the earnings call.

But what is really dinging the stock in after-hours trading on Thursday night, and where the big disappointment came from, was smaller-than-expected subscriber growth for Disney+. The company ended the quarter with 103.6 million (>100% YoY) subscribers to their flagship streaming service, but that was several million short of the 109.256 million estimate as it appears that streaming estimates had gotten too optimistic when considering a great deal of demand was pulled forward by the pandemic, similar to what Netflix (NFLX) experienced in its quarter. Despite the miss, management backed its guidance for 230 million to 260 million subscribers by the end of fiscal 2024.

Another disappointment was the reported miss on average revenue per paid subscriber, which at $3.99 (-29% YoY) missed estimates of $4.01. However, driving the YOY decline was the launch of Disney+ Hotstar, where average revenues were much lower due to lower advertising revenues as a result of the timing of IPL cricket matches in India. When backing out of Hotstar, Disney+ average monthly revenue per paid subscriber was $5.63, which was an increase from the prior quarter of $5.37. Importantly, management said it has not seen any significant increase in churn rates in the United States, since it put through the price increase.

As for the rest of the segment, ESPN+ had 13.8 million paid subscribers, with the average monthly revenue per paid subscriber $4.55 (+$0.07 YoY). Hulu subscribers totaled 41.6 million, with 37.8 million coming from SVOD only, and 3.8 million from LIVE TV + SVOD. The latter is a slight decrease, which management partially attributed to a recent price hike. Hulu's ARPU from SVOD only was $12.08 (flat YoY) and Live TV + SVOD was $81.83 (+21% YoY).

Revenue for Content Sales/Licensing and Other -- the business that includes theatrical distribution, home entertainment, sales of third-party content to TV/SVOD services, live events, and more -- was $1.9 billion (-36% YoY) and roughly in line with the $1.985 billion consensuses, and segment operating income was $312 million, which was higher than $87 million estimates. The company said the increase in operating income was driven by higher TV/SVOD distribution results and lower film and TV cost impairments, partially offset by lower home entertainment distribution results.

Despite the reopening of theaters across the country, offering new movies through premier access on the Disney+ remains a strategy in which management continues to pursue. They do this as a way to attract new subscribers and keep retention rates high. The most notable movie hitting the platform soon is "Black Widow," which will be in theaters and on Disney+ on July 9.

A Day at the Parks...

Now, let's look at parks and products. In Disney Parks, Experiences and Products (DPEP), revenues were $3.173 billion (-53% YoY) and roughly in line with $3.143 billion estimates, while the operating loss of $406 million was better than the $586 million loss estimate.

Breaking down this segment further, Parks & Experiences revenue was $1.997 billion (-43% YoY), matching estimates of $2 billion, with Domestic contributing $1.735 billion (-58% YoY) in revenues while International provided $262 million (-45% YoY). As for operating income, Parks & Experiences reported a loss of $1.060 billion, which was better than estimates of a $1.224 billion loss with Domestic losing $587 million and International down $380 million.

As a reminder, Disneyland Resort, Disneyland Paris, and the cruise operations were closed or suspended for all of the current quarter. And for the parks and resorts that were open in the quarter, Disney operated them at a significantly reduced capacity. Despite these capacity restrictions, every opened park delivered a net positive contribution, which means revenues exceeded the variable costs associated with the opening and is a great sign of profitability. And there is plenty of optimism on the horizon now that the CDC said that vaccinated people no longer need to wear masks in most places.

But even with the current COVID-19 restrictions, management said attendance trends at Walt Disney World steadily improved throughout the quarter, with guest spending per capita increasing double-digits vs. the prior year. Also, the pent-up demand looks to be real here and back at 2019 levels, with strong forward-looking bookings for reservations at both domestic parks. And we remain optimistic that the parks will operate at an even higher margin rate compared to pre-pandemic levels, thanks to a lower cost structure.

The final business line within in this segment is Consumer Products, whose revenue was $1.176 billion and edged estimates of about $1.089 billion, while operating profit of $561 million exceeded estimates of $471 million.

And just to touch on the balance sheet, Disney generated a strong free cash flow figure in the quarter, helped by the reopening of the parks and solid results from direct-to-consumer. Some "choppiness" to free cash flow is expected due to the timing of sports rights, management expects a "more favorable free cash flow" than where it started the year. A rebound in free cash flow should help Disney pay down debt and eventually reinstate the dividend/buybacks, which would be positive for shareholders.

The Big Picture

Overall, the good news was that Disney once again showed that it can be much more profitable than what the market gives it credit for. But the big negative was that the subscriber numbers for Disney+ disappointed after such a long stretch of very strong results. Weaker-than-expected subscribers will overshadow the profits, because Direct-to-Consumer trends have become the most important and most-watched story at the company.

Still, the lower-than-expected count explains why shares are falling roughly 4% after-hours to about $170. At this new level, DIS is roughly 15% off the March all-time high of about $200, which was where we last trimmed our position in our Alert here. A price is coming soon where DIS will get very attractive again, especially with it being a major beneficiary from loosening COVID-19 restrictions at its parks. But for tonight, we will keep our "TWO" rating on the stock and let shares come in.

Action AlertsPLUS, which Cramer co-manages as a charitable trust, is long on DIS.