Disney’s magical pricing power can’t overcome inflation so far

On July 11, 2020, Disney cast members will welcome guests to Walt Disney World Resort’s Magic Kingdom Park.

(Photo by Matt Stroshan / Walt Disney World Resort via Getty Images)

Disney is currently trading like Netflix, and streaming subscriber growth is the catalyst for the most important stocks, but real-world costs continue to rise as Disney + additions declined in the third quarter. I am. And that means, at least in the short term, even Disney has an inflation problem that emphasizes its margins.

Disney has pricing power, which is the envy of most businesses, but it hasn’t improved investor sentiment. Stocks were negative this year, crushed on Thursday, well below the S & P 500 index’s rise of more than 20%, even before earnings disappointment.

It may be time for patience long-term investors to agree, but Disney is a show-me story in the first half of 2022, and rising costs are part of the headwind.

By some criteria, Disney’s recent performance shows how strong the brand is to consumers. Launched at a price of $ 15 for the post-covid reopened park, the Genie + app was purchased by one-third of Walt Disney World guests per day. Disney CEO Bob Chapek said in a statement Wednesday that he wasn’t sure if people were aware of the “significance” of their success.

“This is a very significant increase not only per cap, but also in margins,” says Chapek. He expects “long-term profits in terms of yields.”

Walt Disney World attendance increased by double digits in the third quarter, with per capita spending up about 30% from 2019 levels. The company’s management expects per capita spending to be well above pre-pandemic levels in 2010, offset by the rise. Among other factors, the cost from inflationary pressure.

Wall Street Analysts’ Mind Inflation

In the Parks, Experiences and Products business, margins weakened in the third quarter, and Disney’s revenue phone analysts asked about inflation issues.

“It’s in the minds of every CFO and every senior management team at the company there,” said Disney CFO Christine McCarthy. “Inflationary pressure is what we all see and we are trying to assess and think about how we manage it.”

In the case of Disney, although not macroeconomic, there is inflation associated with fierce competition for content in the streaming war, McCarthy pointed out. “Competing for talent has increased the cost of content for everything involved in production,” she said.

He said it would exacerbate Disney’s real-world inflation problem and spend more than $ 5 billion on capital investment this year. We’re not going to fool Disney to spend more on content, as it will be the key for future blockbuster Disney + subscribers to add quarterly numbers to increase inventory. But CFRA Research analyst Tuna Amobi said, “The amount of capital investment really jumped at us.”

Despite Disney’s strong cost-cutting efforts in earnings, management has seen constant costs in 2010 compared to pre-pandemics as a result of inflationary wage pressures and costs associated with new projects. He said he expects it to continue to rise.

Some analysts have dismissed inflation as a Disney issue.

“Disney has pricing power. Inflation only kills you if you can’t raise prices,” said Laura Martin, an analyst at Needam & Company. Streaming costs are an issue, she said, “but it’s content inflation.”

As a result of Covid’s safety measures, wages in the park have risen and the number of people admitted has decreased, but she said the park business is doing well this year, even with low margins.

Park revenues were above estimates ($ 4.17 billion vs. analysts’ estimates of $ 3.96 billion), but operating profit was well below expectations and international parks suffered losses. According to Atlantic Equities, the $ 640 million profit was well below the $ 901 million consensus. This is the first time all Disney theme parks have opened quarterly since the pandemic began, but nonetheless, CNBC’s earnings analysis shows that the unit’s marginal profits are close to analysts’ expectations. There was no.

And inflation as a keyword was in the analyst’s entire earnings summary note.

“I’m more interested in what the profitability of the business will be after full operation,” said Atlantic Equity. Genie’s success was one of the highlights of the results, but the additional cost pressure was significant. bottom. Inflation is probably the most worrisome. “

Parks’ performance is “optimistic and not yet clear,” Wells Fargo wrote. “Inflation is a risk (wage, product cost). We have acquired Disney, but” we don’t have enough data to confidently discuss it yet, “he wrote.

JP Morgan was also bullish, but mentioned twice the headwinds of inflation. Implement with innovations such as Genie +. The Legacy Parks business has bounced better than expected, and despite short-term cost pressure from inflation, the segment from COVID-19 expects to make more profits in the long run. “

Disney Park Manager planning to respond to rising costs

Disney’s CFO didn’t have an easy solution for higher costs.

“What we see directly in the park business is the inflation of hourly wages, mainly through efforts to renegotiate contracts and pay enough to park workers. And there is a problem in terms of commodity costs. There is, “says McCarthy. I told the analyst.

She told Wall Street last week that she was talking to Disney’s Parks senior team about dealing with inflation.

“There are a lot of things worth discussing. You can adjust the supplier. You can substitute the product. You can cut the size of the part that seems to be suitable for some people’s waistline. Price as needed. You can see, but it’s not. We’re going straight ahead and raising the price … we’re really going to cut the algorithm correctly so that it’s not always possible to do it the same way. As mentioned earlier, we use technology to reduce some of our operating costs, which gives us a little more room to absorb inflation, but we use our heads here and we have I’m trying to figure out ways to mitigate some of these challenges. “

That’s what Wall Street wants to hear, Amobi said, but expectations for the company, which has traded high premiums to its entertainment peers, will also be reset.

“What we expect from them is to find a way to ease the marginal pressure from inflation costs,” he said. “The question is how far and when can they go.”

“Not all of this is completely mitigated. We’re talking about what could take a few quarters, but we want to give the impression that they aren’t sitting vaguely. “Amobi added.

Analysts at Morgan Stanley said the Parks rebound “needs to counter the rapid recovery of Parks’ cost base.” Its cost base has returned from its 19-year level due to several years of labor inflation, including an increase in the minimum wage for Parks employees. While there are clearly positives to earnings forecasts at Parks, the road to previous peak margins can take longer than the road to previous peak revenues. “

Companies with pricing power as strong as Disney has commanded have historically expanded in the face of cost issues, and it will take some time before the lasting impact of inflation on margins becomes apparent.

“Price-determining power makes it even more amazing and tells us more about how businesses can’t pass on those costs to consumers,” Amobi said.

Disney has always been able to outpace inflation by orders of magnitude, measured by the rising prices of Park Pass each year. “It should help them well, but that doesn’t mean that their margin pressures are relieved,” he said.

The quarter showed that growth in streaming, the largest equity catalyst, wasn’t going straight. This isn’t surprising, as it’s also seen in Netflix performance. Currently, Disney also has an unclear inflation problem. How sticky (like wage inflation) and how “temporary” will pass within a few quarters, making it easier for management to hit the finances. target.

McCarthy called an analyst and Disney is back from the pandemic, so he’s already done a lot of work and has some ways to do business on both the revenue and cost sides to optimize margins. “It has changed radically,” he said. However, Disney Parks Experiences and Products’ global business had an overall margin of just under 12%, well below pre-Covid levels.

Wage inflation, commodity launch costs, talent costs, and commodity and service costs were all high-exposure inflation items for Disney, apparent in the quarter when parks were recovering and margins were recovering. The base is low.

“As I said before, I believe it is likely that we will not only come back, but also exceed the previous margin levels of our park. In the long run, these The fundamental changes will result in higher profit margins overall. “

Investor negative sentiment towards Disney can be temporary — in recent years there have been moments when the fear of ESPN’s cord-cutting plunged stock prices before recovery — but the current performance of stock prices is , Indicates that investors need to be convinced again.

“Investors are likely to wait and monitor their approach to equities, at best in the short term,” Barclays said.

Given all the macro data points on rising inflation in recent months and the highest consumer price index this week for the first time in 30 years, companies and investors are not exempt.

“Inflation has been of paramount importance for quite some time and can even delay the achievement of pre-pandemic margins. They will get there, but it will take longer to get there,” Amobi said. Said. “In the case of Disney, some costs are temporary, more permanent, and no one may know …. we always know to deal with this sooner or later. I did. “

Disney’s magical pricing power can’t overcome inflation so far

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