PMI Surveys Show U.K. Economy Struggling With Slow Growth And Rising Prices

The pace of UK economic growth edged down to the joint-lowest for just over a year in September, according to PMI survey data. However, price pressures intensified to suggest that policymakers may continue to talk up rate hike prospects.

Economy on course for modest Q3 growth

The latest survey data indicated that the economy continued to expand at a modest pace in September, but that growth momentum continued to be gradually eroded. The ‘all-sector’ IHS Markit/CIPS PMI slipped further from April’s recent high, down from 53.7 in August to 53.6 in September. The current reading matched February’s recent low to therefore signal the joint-weakest expansion of output since August of last year.

The survey data put the economy on course for another subdued 0.3% expansion in the third quarter, matching the performance seen in the first half of the year, albeit with momentum being gradually lost over the course of the quarter.

With the exception of the slowdown seen in the months surrounding last year’s referendum, the third quarter performance was the worst since the first quarter of 2013.

Slower manufacturing output growth and the first drop in construction activity for 13 months were accompanied by on-going weak service sector growth in September. Although output of the service sector grew at a slightly faster rate than August, the pace of expansion for the third quarter as a whole was the worst recorded for a year.

Within services, consumer-facing companies have reported especially weak growth in recent months, leaving reliance on financial services, transport and business services as the main drivers.

The slow erosion of growth may continue in coming months. Inflows of new business in September were the lowest for 13 months, suggesting demand growth has waned again. Business optimism about the year ahead meanwhile slipped lower again in September, running at a level historically consistent with business activity growth waning further in coming months and the economy slowing towards stagnation at best.

Hiring slowdown amid rising costs

The September surveys also signalled some pull-back in hiring. While August had seen the largest rise in employment since October 2015, September’s jobs growth was the weakest since June reflecting slower payroll gains in both manufacturing and services.

Slower employment growth in part reflected difficulties finding suitable staff, but was also a symptom of a reticence to hire amid worries about future demand and the need to offset higher input costs. Average input cost inflation accelerated in all three sectors, rising as a whole at the steepest rate since February.

Although not matching the highs seen earlier in the year, the rate of input price inflation remained elevated by historical standards, attributed to higher import costs due to sterling’s weakness as well as rising global commodity prices, notably for oil.

Higher costs were often passed on to customers, leading to the largest monthly rise in average prices charged for goods and services since April and suggesting consumer price inflation could rise above 3% in coming months.

Policymakers pulled in different directions

The rise in price pressures will pour further fuel on expectations that the Bank of England will soon follow-up on its increasingly hawkish rhetoric and hike interest rates. However, the decision is likely to be a difficult one, as the waning of the all-sector PMI in September pushes the surveys slightly further into territory that would normally be associated with the central bank loosening rather than tightening policy.

Tech

A Legendary Dividend Growth Stock Trading At Fire Sale Prices

As a contrarian value dividend growth investor, I know the best time to buy a high-quality company is when Wall Street thinks it’s broken.

After careful research, I’ve come to the conclusion that this is how the market feels about Disney (DIS). However, as with most such situations, the market’s short-term focus is blinding it to the company’s likely bright dividend growth future.

That’s why I’ve recently added this legendary entertainment conglomerate to my real money EDDGE 3.0 portfolio, and think you should consider doing the same.

This Is Why Wall Street Is Worried

The key to contrarian value investing is to understand why the market is down on a stock, and to determine whether this is a growth thesis killing problem.

ChartDIS Total Return Price data by YCharts

In other words, “is this time really different”, or will a company that has managed to enrich investors with decades of market crushing total returns persevere and overcome its obstacles and continue its long-term success.

In the case of Disney’s recent 14% slide, there are two main negative factors driving the share price lower.

Source: Earnings Release

I’ll admit that Disney’s earnings performance to date is lackluster at best, with flat revenue and free cash flow (YTD), and declining EPS, despite buying back 3% of its shares in the past year.

Those poor results are largely being blamed on the media segment, specifically troubles at ESPN, which has seen steadily falling subscribers in recent years.

Source: Kenra Investors

In addition, ESPN has faced rising content costs, in order to maintain its dominant position in live sports (it has exclusive rights with the NFL and college football), which has been badly hurting that segment’s bottom line.

Disney has been able to offset this decline somewhat by raising its cable fees, but now Altice USA (ATUS), the nation’s fourth largest cable company (with 5 million subscribers), is challenging Disney’s pricing power.

Specifically, Disney is asking Altice for $ 100 per subscriber per year ($ 8.30 a month) for its total ESPN content, which is a 10% increase over the current average ESPN subscriber fee of $ 7.54.

Understandably the market is concerned that Altice won’t pony up the dough, given that ESPN’s popularity is flagging (potentially due to increased political content on the air which can alienate viewers), sports ratings are down, and ESPN itself is facing a challenging turnaround; having recently let go a significant amount of its on air talent.

And while Altice by itself represents a small contract dispute, Disney investors are worried that should it back down and discount its content that would serve as poor precedent in future negotiations with much larger cable companies.

This Is Why Wall Street Is Wrong

The market’s huge focus on ESPN is likely overblown given that it ultimately represents about 12.5% of Disney’s total revenue.

In addition, Disney is making the right call by launching an ESPN streaming service in 2018, though only time (and pricing) will tell whether or not it will be able to stabilize the brand’s bottom line.

However, to truly understand Disney’s growth potential requires looking at its other segments, such as the wildly successful studio segment.

Of course, we need to keep in mind that some of Disney’s business segments, especially its studios, are highly cyclical due to the lumpy nature of the movie business.

For example, 2017’s large YTD decrease in studio revenue and earnings isn’t necessarily a sign that Disney has lost its mojo, but rather that 2016 was a triumph, where the company’s especially large number of films released dominated the global box office.


Source: Boxofficemojo

For example, in 2017, there have been far fewer films than last year.

Yet even before Disney releases: Thor: Ragnarok, Star Wars: The Last Jedi, and Pixar’s Coco, it still boasts three of the top 10, and four of the top 20 movies of the year so far. In addition, on a per movie basis, Disney is actually doing better than last year.

And given the historical track record of how well Star Wars, Marvel, and Pixar films do internationally, it’s likely that Disney can expect around $ 2.5 to $ 3 billion combined from these remaining releases, and further domination of the global box office (six of the top 10 and seven of the top 20 releases this year). In fact, once these three likely major blockbusters come out, Disney’s 2017 average box office per film should rise to about $ 725 to $ 750 million, far higher than its record 2016 haul.

And the long-term view is similarly bright as Disney benefits not just from Star Wars and Marvel franchises but also Pixar, Disney Animation, and the continuing trend of live action remakes of its most popular animated classics (including this year’s most popular global movie Beauty and The Beast).

Add to this the fact that Disney’s cable networks are seeing strong international growth, and it’s obvious that, while the domestic market will always be important, Disney’s true growth prospects lie in its dominance overseas, especially in faster growing emerging markets such as India and China.

This also applies to its booming parks segment, which saw successful openings of Shanghai Disney Resort and and improved performance of Disneyland Paris, spurring impressive 17% earnings growth for the division.

According to Technavio, the amusement park industry is set to grow 11% CAGR through 2021, and Disney is well situated to gain a fair amount of this business thanks to continued expansion and revamping of its properties, including the recently opened Pandora World Of Avatar attraction at its Animal Kingdom, plus dozens of new attractions outlined by the D23 plan:

  • Star Wars: Galaxy’s Edge, part of Disneyland and Disney World Hollywood Studios, opening 2019 and featuring two feature rides, the Millennium Falcon, and Star Wars battle experience.
  • Guardians Of The Galaxy ride at California Adventure will be expanded into a full fledged Marvel Land.
  • Star Wars Luxury Resort: the company’s “most experiential concept ever,” a starship themed hotel where every window has a view of space.
  • Major upgrade of Epcot including: a highly upgraded Future World, a Guardians Of The Galaxy ride, and a Ratatouille attraction in the French pavilion, a Mission to Mars ride, and a space themed restaurant.
  • An intense roller coaster Tron ride next to Star Wars Hotel in Magic Kingdom, as well as a new theater and show in that park.
  • Toy Story Land in Hollywood Studios.
  • New Disney Riviera Resort near Epcot, part of the exclusive Disney Vacation Club.
  • Pixar Land at Disney World California Adventure.
  • New York Hotel in Disneyland Paris to be rebranded and refurbished as a Marvel based resort.

In other words, Disney, which operates seven of the top 12 and 12 of the top 25 most visited theme parks in the world, will continue to dominate this growing and highly lucrative industry.

And let’s not forget that while the consumer segment has been having a down year (due to tough comps), Disney is a legend at monetizing its brands through licensing and toys. This segment should continue to grow in the coming decades (about 6% a year according to analysts such as Morningstar’s Neil Macker); especially thanks to the company’s popularity in emerging markets.

Finally, while there is no guarantee of success, should the GOP tax reform plan pass, then Disney is likely to benefit immensely from the lowering of corporate tax rates to 20%.

That’s because the company’s TTM effective tax rate was 32.8%. Thus, should that rate drop to 20%, then Disney’s bottom line (EPS and FCF) would grow by an impressive 39%; something the stock is clearly not pricing in right now (forward PE would drop to 11.1).

Long-Term Dividend Profile Makes Disney An Income Investor’s Dream

Disney has an impressive record as a fast dividend grower.

Source: Simply Safe Dividends

Company Yield TTM FCF Payout Ratio 10-Year Projected Dividend Growth 10-Year Projected Annual Total Return
Disney 1.6% 27.6% 7.9% to 10% 9.5% to 11.6%
S&P 500 1.9% 39.5% 5.9% 9.1%

Sources: Gurufocus, Fast Graphs, Factset Research, Multipl.com, Moneychimp.com

However, I’m sure that many readers will take one look at Disney’s low yield and reject it as an income investment.

I understand that, and in fact, I agree that if you are someone looking to live off dividends in retirement, and have 10 years or less before you plan to exit the labor force (or a retired now), then indeed Disney likely isn’t for you.

However, if you have 10+ years to let the company compound its payout, then it’s actually an excellent income investment. That’s especially true given the rock solid dividend safety (strong balance sheet and low payout ratio), and solid prospects for long-term double-digit dividend growth.

Years Projected Inflation Adjusted Yield On Invested Capital
5 2.35%
10 3.45%
15 5.10%
20 7.45%
25 11.0%
30 16.1%
35 23.65%
40 34.75%
45 51.1%
50 75.0%
55 110.25%
60 162.0%
65 238.05%
70 349.75%
75 514.0%

For example, assuming a conservative 10% long-term dividend growth rate (not unrealistic given that Disney’s 30-year dividend CAGR is 17.3%), and 2% inflation rate, then Disney shares bought today, if given enough time to compound, can become a fantastic retirement stock.

The key is to start as early as possible, meaning that if you are young and just starting out saving and investing (in your 20’s), then 40 to 50 years of dividend growth compounding can greatly help ensure your financial future.

And if you are planning to have children (as I am eventually), then I recommend you consider buying some Disney stock for them, because such a gift, with potentially 70 to 75 years of compounding time could wind up incredibly valuable. This is both as an income source or an asset that can be sold and the funds allocated elsewhere, such as higher-yielding stocks if they so choose.

One Of The Few Stocks Trading At Fire Sale Prices Right Now

ChartDIS Total Return Price data by YCharts

Thanks to its recent weakness (a 14% decline of its recent high), Disney has underperformed the market by about 11% in the past year. However, that just creates a potentially excellent buying opportunity.

Company Forward PE Historical PE Yield Historical Yield
Disney 15.4 17.2 1.6% 1.2%
Industry Median 22.9 NA 1.8% NA

Source: Gurufocus

After all, when we compare the company’s forward PE ratio to either that of its peers, or its own historical norm, we find Disney highly undervalued.

That’s only more so if we consider the most important valuation metric to dividend investors, the yield, and where it stands in comparison to its usual levels.

Source: Yield Chart

For example, while a 1.6% yield isn’t necessarily high in and of itself, the fact remains that over the past 22 years, Disney’s yield has only been higher about 7.5% of the time.

In my book, that makes this dividend growth stock highly appealing, especially given the company’s wide moat and “buy and hold forever” nature.

But of course, all such backwards looking valuation metrics have a major flaw, which is that all profits are derived from the future.

Which is why my favorite valuation metric for dividend growth stocks is a discounted free cash flow or DCF analysis.

TTM FCF/Share Projected 10-Year FCF/Share Growth Rate Fair Value Estimate Growth Baked Into Current Share Price Margin Of Safety
$ 5.40 6.9% (conservative case) $ 140.17 2.4% 30%
9.3% (likely case) $ 169.17 42%
11.2% (bullish case) $ 196.22 50%

Sources: Fast Graphs, Gurufocus, Morningstar

Basically, the idea is that a company’s fair or intrinsic value is the net present value of all future free cash flow.

I use a 9.0% discount rate because that is the opportunity cost of money. Specifically, the S&P 500’s (the best default alternative to any individual stock) historical 9.07% return, net of expense ratio for a low cost ETF, can realistically be expected to generate 9.0% total returns.

Such an analysis shows that even using conservative FCF/share growth estimates, Disney is incredibly undervalued, thanks to the market pricing in essentially flat FCF/share growth forever.

However, I find this a ludicrously pessimistic assumption given this growth rate is about 50% below the global economy’s growth rate, and Disney’s strong international opportunities mean it’s virtually certain to clear this very low performance bar.

In other words, Disney now offers one of the largest margins of safety for a Grade A (low risk) quality company that you’ll find in this overheated market.

Risks To Keep In Mind

While I am bullish on Disney in the long term, there are several short- to medium-term risks to keep in mind.

First, ESPN, which represents 25% of Disney’s FCF, is likely to continue struggling in the face of ongoing cord-cutting and declining sports ratings. Worse yet, sports programming costs are only going to make things worse for now as Disney recently had to renew its contracts with the MLB, NBA, and NFL by almost $ 2 billion a year.

Which means that ESPN, which the market is obsessing over right now, will continue to be a drag on the company’s growth, and could result in further share price weakness.

Now personally, I would love for further opportunities to add to my position at lower prices; however, if the price falls too low, then activist investors could step in and lobby for a selling or spinning off of ESPN; something media deal making legend John Malone has recommended.

The risk of such a sale could be especially high in mid-2019, since CEO Bob Iger is set to retire at the end of July of that year. His successor could feel pressure to “do something” and sell ESPN.

That in turn would slash FCF/share and could greatly impair Disney’s ability to grow its dividend at its historically high rates.

And speaking of Iger stepping down, we can’t forget the succession risk that will come with a new CEO, whoever that may be. Personally, I’m confident that Disney’s fourth extension of Iger’s contract to give them more time to prepare and groom a worthy successor means the company will continue on a similar trajectory once the man is gone.

Finally, we can’t forget that the entertainment world is constantly shifting, with changing consumer tastes and new disruptive technologies.

While Disney’s $ 2.6 billion purchase of 75% of BAMtech, ahead of its launching of its own streaming service in 2019 may end up generating a strong recurring revenue stream, UBS has estimated that Disney would need 32 million subscribers to break even at $ 9 per month.

In the meantime, the company will have to increase its capital spending to build its streaming service, and upon its launch, forgo $ 500 million it’s currently getting from licensing its content to other companies such as Netflix (NFLX).

Given the market’s short-term focus, any missteps in launching its streaming services could put further downward pressure on the stock in 2019, and further fuel calls for potentially knee-jerk reactions from the new CEO (unless Iger’s contract is extended for the firth time).

Bottom Line: Disney’s Unbeatable Brands Own The Future Of Entertainment And The Current Price Is Too Good To Pass Up

Don’t get me wrong, I’m not saying that Disney’s shares are certain to rise in the short term because markets can remain irrational for long periods of time.

However, if you are, like me, a value focused dividend growth investor, with a time horizon of 10+ years, then today Disney shares represent one of the most undervalued grade A opportunities you can find in this otherwise overheated market.

Which is why, when I saw Disney within 5% of its 52-week low recently, I took the opportunity to add it to my own portfolio, and recommend you consider doing the same.

Disclosure: I am/we are long DIS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Tech