Behind The Headlines: What The Latest Earnings Report Reveals About Disney's Future

The recent earnings report of Walt Disney Co DIS has revealed a mixed bag of results for investors. Although the company's EPS of $0.93 was in line with consensus estimates, it fell short of expectations as Disney has a track record of exceeding profit estimates. However, Disney's revenues of $21.82B exceeded the consensus of $21.79B, experiencing a YoY increase of 13%, primarily due to a remarkable 17% sales boost in the parks, experiences, and products segment. This segment's impressive performance can be attributed to the receding pandemic, which provided a significant boost to the company's revenue growth.

Moreover, Disney's focus on free cash flow (FCF) seems to be paying off, as evidenced by a notable increase in FCF from $686M to $1,987M. However, it is important to note that the parks segment is primarily responsible for this positive trend: ahead of a possible economic downturn, that’s not the best position to be in.

Despite seeing a ramp up in Disney's parks business and healthy revenue growth, the company experienced a decline in profitability, with segment operating profit decreasing by 11% YoY to just $3.3 billion. This decline is particularly concerning for investors, as operating leverage is not currently working in Disney's favor. The decline in profitability can be mostly attributed to Disney's media and entertainment business, which experienced a nearly 50% decrease in operating income. On the other hand, Disney's parks business witnessed an impressive increase of more than 20% in profits. While this segment remains a significant driver of profits, it is not substantial enough to fully offset the headwinds faced by the media and entertainment franchise.

This trend is nothing new, and was also observed in Disney's Q1 where parks profits were up, but media and entertainment generated lower profits. Despite Disney's revenues growing nicely, the company's profit performance has been weak due to significant margin compression over the past few years, primarily driven by its investments in the streaming business. Indeed, creating content for 10 million or 100 million users incurs largely the same expenses, and a streaming service that has not hit sufficient scale is bound to remain unprofitable. Although investors were aware of this from the start, their hopes for a better profit performance led to disappointment and contributed to the drop in Disney's share price from the highs of 2021.

The declining streaming subscriptions in Disney's media and entertainment unit is a concerning trend for the company's growth prospects. Indeed, the loss of 4 million paid subscribers during the second quarter marks a significant setback for a business that relies heavily on subscriber growth to eventually become profitable. The disappointing results caused shares to decline by almost 5% in after-hours trading, as analysts were expecting the service to add 1.7 million subscribers instead.

Notably, the subscription price increase from $5.95 to just over $7 has led to the loss of domestic subscribers for the first time ever, which is concerning since these subscribers pay about 61% more than the global average monthly revenue per user. However, if profitability is the goal, as stated by CEO Robert Iger, then this could be a positive development in the medium-term for investors. While the decline in subscriptions is a short-term setback, focusing on profitability could help Disney's streaming business become sustainable and profitable in the long run.

Of course, let’s not forget that the macro-environment likely plays a role as well. With persistent inflation that reduces their purchasing power and the looming possibility of a recession, consumers cut back on discretionary spending such as non-essential subscription services. However, if macro is the main reason behind this decline in subscriber count, then we should see it climb again once economic conditions improve. This, of course, provided that the company continues to create compelling content that can attract new subscribers.