The Worldwide Leader? Barclays Cuts Disney To Underweight

• Walt Disney Co DIS shares have declined 15.93 percent over the past six months, to a low of $98.48 on January 13.
• Barclays’ Kannan Venkateshwar has downgraded the rating on the company from Equal Weight to Underweight, while lowering the price target from $98 to $89.
• Although "Star Wars" is expected to be a tailwind for CYQ4, Venkateshwar believes that there could be valuation compression in the longer term, along with potential risk to earnings.

Analyst Kannan Venkateshwar explained that “Disney has historically traded at a premium to the rest of the industry on account of the perceived (1) inelasticity of demand for ESPN, (2) company's franchise studio acquisitions and (3) diversified revenue stream.”

The ESPN Effect

However, ESPN is expected to drive the company to underperform the sector in 2017, given that this business is the most exposed to the “secularly fragmenting” media environment.

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This means that given ESPN’s fixed cost structure with a variable revenue model, subscriber losses would have a disproportionate effect on the business model.

“In our opinion, ESPN accounts for a disproportionate share of Disney's cash flow and the gap between OCF and EBIT growth over the last 2 years likely already points to this pressure from subscriber losses,” Venkateshwar said.

In addition, Disney’s studio business trades at a premium, based on the assumption that franchise acquisitions de-risk the business mode, which according to the Barclay’s report, is a flawed assumption.

“Although Disney has strong franchises… we note that over the past 8 years, the company's studio and merchandizing revenue has had little growth, especially adjusted for Frozen,” the report explained.

With major catalysts now in the past, increasing pressure on ESPN, balance sheet liabilities, possibility of management transition in the next two years, Venkateshwar expects the stock to at best trade in line with peers.