Disney: Theme park unexpectedly cooling down, can the reversal continue?

Hello everyone, I am Dolphin Jun!

$Disney(DIS.US) Disney released its 2024 fiscal third quarter (CY24Q2) results before the US stock market on August 7. Overall, the performance is mixed, with positive aspects following the trend of the previous quarters and recent changes, such as the continuous price increases in streaming media accelerating the reduction of losses, and high box office hits quickly driving content sales from loss to profit. However, the negative aspect is that the theme parks have cooled off ahead of time. This was also reflected in the market after Comcast's financial report (double-digit decline in park revenue) was released. Disney's management outlook also indicates that the slowdown in local demand will be more pronounced in the next quarter.

Specifically, the core information from the financial report is as follows:

1. Profit remains the first goal: Disney continues to reduce costs and increase efficiency. The strong performance of high box office hits and price increases in streaming media had a significant impact on the group's profit performance in the third quarter, exceeding market expectations for operating profit and adjusted EPS. Due to the better-than-expected profit performance, after raising EPS growth by 5 percentage points to 25% in the previous quarter, the management further raised it to 30% this time.

2. Growth is recovering, but there are also hidden concerns: Overall, the revenue side meets market expectations with a year-on-year growth of 3.5%, but there are differences in performance among different business segments. Among them:

(1) The entertainment business overall performed better than expected, with slightly better performance in streaming media and film sales revenue. The former is due to price increases for Disney+ and Hulu, as well as a slight increase in subscription numbers, while the latter is due to the impressive box office performance of films like "The Incredibles 2".

Looking ahead to the fourth quarter, the company expects the DTC business to continue reducing losses, also driven by both volume and price increases (recently raising bundled package prices for Disney+ and Hulu by 10%-15%). Content sales are also not a problem, with strong box office performances from "The Incredibles 2", "Planet of the Apes", and the recently released "Deadpool and Wolverine".

(2) The sports business performed steadily, meeting expectations without surprises. The future outlook will be more interesting after the launch of the new version of ESPN in 2025.

(3) The main issue in this performance is the park business. Experiences revenue in the third quarter significantly slowed to 2.3%, indicating that the demand previously suppressed by the pandemic has rapidly cooled down after experiencing a year of high heat. Both local parks in terms of attendance and per capita spending are no longer growing, and international parks overall also show a significant slowdown in growth.

Additionally, the management's outlook for the next quarter is not optimistic, with an expected single-digit profit decline, which may translate to either no growth or a low single-digit decline in revenue.

3. Investment slowdown easing, signs of expansion: Free cash flow in the third quarter was 1.23 billion, a year-on-year decrease. Although operating profit has improved, there has been an increase in some other cash outflows related to operations. In addition, capital expenditures for investments in theme parks and other areas have also increased year-on-year The company's cash flow target for 2024 is an annual operating cash flow of 14 billion and a free cash flow of 8 billion.

On the other hand, although investment expenditures related to content are still declining year-on-year, the rate of decline has been continuously slowing down. Considering Disney's current content reserves (with a large number of movie release dates postponed), it is expected that after profits recover to the target value, Disney may also restart a new investment cycle similar to Netflix.

4. Performance Indicators Overview

Dolphin's Viewpoint

In the third quarter, in terms of the creation, sale, and broadcast of entertainment content, it basically followed our previous expectations, showing an overall warming trend quarter by quarter.

However, the biggest flaw appeared in the past two years' performance pillar - the theme park business. Although there are signs of cooling local park demand, as evidenced by Comcast's financial report two weeks ago, the market adjustment was already evident when Disney's decline followed. Disney management's guidance for a single-digit decline in the next quarter further confirms the actual situation of cooling demand.

In addition, for local theme parks in the United States, Disney may also face some competition from the new Epic park by Universal in 2025. In other words, the disappearance of post-pandemic dividends and increased competition may bring some growth pressure to Disney's theme park business. However, Dolphin believes that Disney's theme park business still has relatively competitive strength in the industry, and is unlikely to experience a double-digit decline like Comcast. We expect more of a return to a stable state as in previous years, with revenue remaining stable or growing in single digits.

From a group perspective, the sudden slowdown in demand for the park business, which accounts for 40% of revenue and contributes 53% of operating profit, may somewhat delay Disney's return to healthy growth. However, in the short term, there are other positive driving factors. Measures against account sharing and price increases will have a certain impact on the streaming media business, and the content sales business, which is entering this wave of blockbuster harvest, will also revive. Considering the relatively low valuation at present, as long as the guidance for the park business in the future is not too drastic, the market reaction should not be too intense, possibly prolonging the bottoming period. It is recommended to pay attention to more discussions by management on the demand situation for theme parks during the conference call.

Below is a detailed financial report

I. Understanding Disney

As a nearly century-old entertainment kingdom, Disney's business structure has also undergone multiple adjustments. Dolphin has provided a detailed introduction in "Disney: The "Anti-aging Technique" of a Century-old Princess".

In the past year, there have been major adjustments at the group level, not only changing the leadership team but also altering the business structure and changing the strategic focus. Under the new business structure, it is mainly divided into three major segments - [Entertainment], [Sports], [Experience]:

1. The difference between the original architecture and the new architecture?

The new architecture mainly highlights ESPN's strategic position, separating ESPN channels and ESPN+ to establish a sports business department, showing the company's emphasis.

(1) Entertainment business includes: original linear channels, DTC (excluding ESPN+), content sales, while disposing of some redundant business lines and low-revenue traditional channels in the integration process.

(2) Sports business includes: ESPN channels, ESPN+, Star

(3) Experience business includes: park experiences, travel and cruise, merchandise consumption, similar to previous businesses, but due to some adjustments in the business, there are some discrepancies in specific financial data compared to before.

2. Investment logic framework

(1) The framework change reflects an important strategic adjustment - content and distribution channels are no longer separated into two businesses, but integrated together, with the new business structure more based on different content divisions.

This may solve a problem at the source - the same content may be suitable for initial release on different channels. In the past two years, Disney has been struggling with whether to release popular blockbusters on Disney+ or in theaters first. After trying simultaneous online and offline releases, it ended up affecting the final box office performance of some popular films. This then affected actor revenue sharing and damaged Disney's cooperation with some star actors.

(2) The Experience business has matured over the years, with the support of a strong IP reserve, Disney's leading position in the theme park business is stable, more influenced by overall consumption. Normally, it can be seen as a stable cash flow.

(3) Entertainment essentially involves the production and distribution of Disney films, including several well-known studios, traditional channels, and streaming channels, so revenue changes are mainly related to Disney's film scheduling and overall film market consumption.

The streaming business remains Disney's future long-term business focus. However, in the past two years, it was originally seen as a growth business that could bring incremental revenue and profits to Disney's traditional stable business. But the competition in the front-end streaming intensified during the pandemic. Disney, lacking the accumulated advantage of producing original series content, made huge investments but ended up in losses.

As the two ends of the seesaw, while streaming development is hot, traditional media's old business naturally cannot thrive on its own. With the trend of decline in traditional media, streaming for Disney is not entirely incremental, but largely compensating for the decline in traditional channels.

(4) Disney's new favorite, the Sports business, may be a new growth path that has emerged. Although ESPN has been operating within Disney for many years, sports content and related industries are also increasingly in the sights of many streaming companies, such as Netflix, which has mentioned their focus on sports content and increased investment multiple times.

The recent change is that Disney will join hands with Warner Bros., integrate its own Fox content, and launch a new version of ESPN by 2025, essentially doubling down on the sports track

II. Profits Exceed Expectations, When Will the Investment Cycle Restart

In the third quarter, the group's operating profit reached $4.23 billion, a year-on-year increase of 19%, with an operating profit margin of 18.3%, up 1 percentage point quarter-on-quarter and 2.5 percentage points year-on-year. The main reasons for this are:

(1) The outstanding performance of reducing losses in streaming media (excluding ESPN+ and Star) once again, mainly due to the implementation of strategies such as price increases and actively reducing costs to increase efficiency.

(2) "The Incredibles 2" global box office revenue reached $1.55 billion, currently ranking first in 2024's film box office, making a major contribution to turning losses into profits in content sales in the third quarter.

(3) Cable TV closed some channels for updates, reducing content costs, focusing more on channels with better monetization efficiency, thereby overall increasing profitability.

From the perspective of profit contribution, the theme park business still accounts for more than half, followed by cable TV and sports business. Therefore, the slowdown in demand for the theme park business leading to a decline in profits will have a more obvious drag on the overall profitability of the group.

Looking ahead, the cost reduction and efficiency improvement in the content business will continue to be strictly implemented at least throughout this year. Therefore, the growth guidance for adjusted EPS has been raised by management from 25% in the previous quarter to 30% growth. In addition, management's cash flow expectations remain unchanged, with net cash inflows from operating activities of $14 billion and free cash flow of $8 billion.

However, Dolphin predicts that there will be an increase in operating-related investment expenditures in the 2025 fiscal year, especially in content investment. Over the past two years, due to proactive streamlining and the impact of the Hollywood strike, Disney's lack of reserve content has gradually become apparent - with several new movie release dates being postponed repeatedly.

Looking at the recent quarters' content investments, although the investment scale is still declining year-on-year, the rate of decline has gradually slowed down, and a rebound is expected to be seen in the 2025 fiscal year. This trend in the investment cycle can also be observed in Netflix

III. DTC: User Growth Slightly Increases, Continues to Raise Prices

In the third quarter, Disney+ added 200,000 net users in North America, with the movie "The Incredibles 2" attracting viewers. Nearly 1.3 million users revisited the classic "The Incredibles" on Disney+.

During this period, it was still within the price increase cycle, which may have had some impact on user growth. Nevertheless, Disney recently announced a price increase for the bundle package of Disney+ and Hulu. In Europe and India, there continues to be a month-on-month loss in users.

By the end of this quarter, Disney+ had 153.8 million subscribers, ESPN+ had 24.9 million, Hulu had 51.1 million, totaling 229.8 million subscribers. In the short term, the company's focus on streaming media is still on raising prices to reduce losses. The company's subscription user growth guidance for the next quarter is not particularly high, indicating moderate growth.

Although content spending in the third quarter continued to decline year-on-year, the rate of decline has slowed significantly. Considering the issue of content scarcity that has persisted for several quarters, there seems to be a sign of a rebound in content investment and a return to expansion for the company. In terms of investment pace, Disney's investment rhythm is similar to Netflix's, but this time, possibly due to its own profitability issues, the new investment cycle is slightly later than Netflix's.

4. Theme Parks: Rapid Cooling of the Domestic Market

In the third quarter, revenue from theme parks and consumer products was 8.4 billion, a year-on-year increase of 2.3%, which is significantly slower than the previous quarter. Within the internal structure, the growth rate of the park business was 3.4%, while consumer products returned to a decline. Although there were expectations for the fading of the post-pandemic dividend, the visible speed of demand cooling is rapid.

Further breakdown of changes in volume and price driving factors. The number of local park visitors and per capita spending are no longer increasing, while international theme parks, although still experiencing growth in visitor numbers, are starting to see a year-on-year decline in per capita spending. Within international theme parks, the main growth is still coming from the Hong Kong park, but the Shanghai park is experiencing a slight decline due to a high base from the previous year.

V. Blockbusters finally attracting audiences, gradually entering a period of intensive releases

In the third quarter, content sales revenue decreased by 4.4% year-on-year, but there has been a noticeable improvement in the trend on a quarter-on-quarter basis, mainly driven by the release of "The Incredibles 2" on June 14, which grossed $1.55 billion at the box office and currently ranks first in this year's box office rankings.

Looking ahead to the fourth quarter and next year, the recently released "Deadpool and Wolverine" is also showing a trend of popularity (reaching $850 million in box office revenue in two weeks). In addition, many Marvel blockbusters (part of the previously delayed product cycle) are scheduled to be released after 4Q24FY, which is expected to further expand the revenue scale of content sales.

VI. Cable media focusing on efficient operations

In the third quarter, cable TV revenue continued to decline by 7.3% year-on-year, struggling to resist the overall trend of cord-cutting by users. Looking at revenue breakdown, similar to the previous quarter, subscription revenue is declining more than advertising revenue. Dolphin believes that from the second half of the fiscal year to Q1 of 2025, which coincides with a key election period, political advertising revenue is expected to temporarily slow down the decline in cable media.

At the same time, considering the inevitability of user attrition, Disney has long prioritized investments in cable media, closing some low-efficiency monetization channels, leading to an increase in the operating profit margin of the department.

As a large amount of operational data is not disclosed in the performance report, it is recommended to pay attention to the full version of the financial report and conference call minutes, or directly check the "Deep Data" section on the Longbridge app.

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