Disney (DIS) is one of the most iconic companies in the world and has rewarded shareholders with 11.7% annual dividend growth over the last 20 years.
However, that hasn't stopped the stock from slumping more than 20% since hitting an all-time high in late 2015.
Today, Disney's stock trades for about 15.3x forward earnings estimates.
It's unusual to find such a high quality business trading at a seemingly reasonable price.
I wrote my initial thesis on Disney in mid-February 2016 (click here to read it). With the stock's continued slump, now is a good time to dig deeper into some of the concerns I have with the business.
Let's take a closer look at the issues weighing on Disney and whether or not a possible buying opportunity could be around the corner.
I have three primary concerns:
The first and third issues identified above could materially impact Disney's long-term earnings power and are largely up in the air.
I'm not concerned with the second risk factor's impact on Disney's earnings potential, but I believe it has potential to unfavorably impact the company's near-term earnings growth over the next couple of years. I would actually view this as a buying opportunity if it materializes.
Let's dive in.
Risk 1: Disney's CEO Succession Plan Creates Uncertainty
Disney's Chief Executive Officer Robert Iger, 65, has plans to retire in June 2018 after leading the company since 2005.
His planned retirement has already been delayed three times, and it's possible yet another extension could be around the corner.
In April 2016, Iger's intended successor, Chief Operating Office Tom Staggs, unexpectedly resigned from the company.
The board is now expected to focus more heavily on outside CEO candidates since most of Disney's other senior executives have no more than a few years of experience at the company (Staggs had been with Disney more than 25 years).
Disney is in the middle of navigating a rapidly evolving media landscape. The company's risk profile would seem to rise if Iger sticks with his 2018 retirement plans and an outsider is brought in to run the company, in my view.
A lot can change in two years (Iger could also delay his retirement yet again), but I would prefer to have greater clarity on the company's succession plans and strategic roadmap given the secular changes reshaping media companies (more on that below).
Risk 2: Studio Entertainment Profit Growth Could Be Near a Cyclical Top
Disney's Studio Entertainment segment primarily makes money from producing the company's films.
While this segment accounted for less than 15% of Disney's overall revenue last year, it has great strategic importance for the overall company.
When Disney delivers a hit film, the company can leverage its popular characters across its different businesses and technology platforms to create a long stream of income.
Mickey Mouse is still bringing in tons of cash nearly 90 years after its initial launch, for example.
The value of popular characters cannot be overstated, but there is little certainty involved with forecasting how successful a new film might be.
Film producers incur substantial production and marketing costs to create and advertise movies before they are released in theaters.
Many films have flopped in the box office and lost tens of millions of dollars as a result of their steep production costs and lack of popularity.
Simply put, some years are going to be (much) better than others depending on which movies Disney releases and how popular they become.
Take a look at the chart below to see the Studio Entertainment segment's income volatility if you don't believe me.
Disney's film unit has been on fire recently. In fact, seven of the company's top 10 all-time highest grossing movies were released in the last three years.
Big hits include Star Wars: The Force Awakens, Frozen, Iron Man 3, Finding Dory, and Avengers: Age of Ultron.
As a result, Studio Entertainment profits have more than tripled since 2013 and are up even more over the last decade despite an overall decline in revenue.
