S&P Downgrades Disney's Credit Rating, Adding Uncertainty to the Dividend
Earlier today, Standard & Poor's lowered Walt Disney's (DIS) credit rating from A to A- and maintained a negative outlook on the firm's rating.
Given the rising credit rating pressure facing Disney, management's desire to maintain a mid-single A leverage profile, and the increased likelihood of theme park profitability remaining weak for longer, we are downgrading the company's Dividend Safety Score from Borderline Safe to Unsafe.
As we discussed in our April 5 note, almost all of Disney's businesses are under pressure due to the COVID-19 pandemic, reducing its ability to pay down debt following its $71 billion acquisition of 21st Century Fox in 2019.
Disney's theme parks (38% of sales) remain closed indefinitely. Its TV and film studios (16%) can't complete production or release films into closed movie theaters. And the firm's TV and cable networks are suffering from the loss of live sports, hurting advertising revenue (10%).
Coupled with the high fixed costs required to maintain most of these operations, especially theme parks, Disney is losing money with each passing day.
A sharp and meaningful rebound seems increasingly unlikely.
On April 16, President Trump issued guidelines for gradually ending lockdowns, which include physical distancing protocols for the foreseeable future.
Even once large venues reopen and social distancing guidelines are relaxed, many consumers could be slow to return to high-traffic areas.
It could be a while before we get to that point, though. Many states have already extended or will consider extending their lockdowns beyond April 30.
Disney will probably have a different look after the crisis, but it will get through this. The dividend's survival remains less certain.
In its note today, S&P suggested it could downgrade Disney's credit rating another notch if parks take a long time to reopen or return to healthy demand levels. S&P will also see if Disney takes any additional actions to deleverage faster:
Given the rising credit rating pressure facing Disney, management's desire to maintain a mid-single A leverage profile, and the increased likelihood of theme park profitability remaining weak for longer, we are downgrading the company's Dividend Safety Score from Borderline Safe to Unsafe.
As we discussed in our April 5 note, almost all of Disney's businesses are under pressure due to the COVID-19 pandemic, reducing its ability to pay down debt following its $71 billion acquisition of 21st Century Fox in 2019.
Disney's theme parks (38% of sales) remain closed indefinitely. Its TV and film studios (16%) can't complete production or release films into closed movie theaters. And the firm's TV and cable networks are suffering from the loss of live sports, hurting advertising revenue (10%).
Coupled with the high fixed costs required to maintain most of these operations, especially theme parks, Disney is losing money with each passing day.
A sharp and meaningful rebound seems increasingly unlikely.
On April 16, President Trump issued guidelines for gradually ending lockdowns, which include physical distancing protocols for the foreseeable future.
Even once large venues reopen and social distancing guidelines are relaxed, many consumers could be slow to return to high-traffic areas.
It could be a while before we get to that point, though. Many states have already extended or will consider extending their lockdowns beyond April 30.
Disney will probably have a different look after the crisis, but it will get through this. The dividend's survival remains less certain.
In its note today, S&P suggested it could downgrade Disney's credit rating another notch if parks take a long time to reopen or return to healthy demand levels. S&P will also see if Disney takes any additional actions to deleverage faster:
We expect to resolve the [negative outlook] as we get clarity on when the U.S. parks will reopen and what a post-COVID-19 world will look like. In addition, we will evaluate the steps that the company plans to take, beyond those operational actions already announced, to improve the pace of deleveraging. This could include financial policy, capital expenditures, or asset sales...
We could lower our rating on Disney if we no longer believe that it can reduce adjusted leverage below 3x by fiscal 2022. This could be caused by the economic recession continuing well into 2021, or, more likely, continued consumer concerns about social distancing delaying a return to normalcy for theme park attendance.
Based on what we know today, we believe it's reasonable to assume that theme parks will not reopen sooner than expected and attendance will take time to recover to normal levels.
An analyst at UBS even believes that Disney's parks will not reopen until next year.
In other words, without pulling other levers, Disney will struggle to reduce its leverage below S&P's 3x threshold by fiscal 2022, risking another credit rating downgrade.
Prior to the pandemic, management prioritized reducing debt to get the firm's leverage ratio in line with a mid-single A credit rating (below 2.5x leverage).
As part of that plan, Disney had suspended share buybacks and kept its semiannual dividend frozen to retain as much cash flow as possible for deleveraging.
Now, Disney is (temporarily) losing money and seeing its leverage metrics move higher.
Disney's dividend costs the company $3.2 billion annually and represents the easiest lever management can pull to protect the balance sheet during these uncertain times.
However, this is a tough call because Disney has the liquidity to continue its dividend if it wants to.
Disney ended 2019 with $6.8 billion of cash on hand and issued $6 billion of debt on March 19, bringing its cash balance to $12.8 billion.
Disney also has $17.25 billion of available borrowing capacity under four credit facilities expiring in March 2021 ($5.25 billion), April 2021 ($5 billion), March 2023 ($4 billion), and March 2025 ($3 billion).
That's plenty of firepower to cover Disney's $6.5 billion of commercial paper outstanding as well as its $3.5 billion of scheduled debt maturities remaining in fiscal 2020, according to Fitch.
However, management couldn't be faulted for wanting to preserve as much capital as possible in this environment. One analyst believes Disney is burning through $30 million or more a day while its parks remain closed.
Regardless of Disney's dividend decision, which could come as soon as next month, we believe the firm's financial position remains solid and reiterate the closing remarks we made in our April 5 note:
With the operating environment looking like it could remain weaker for longer, temporarily suspending its already frozen semiannual dividend would provide Disney with more financial flexibility to protect its balance sheet and continue investing in long-term initiatives like Disney+ (which is losing money today).
Disney has a longstanding commitment to its dividend, but it has never faced a perfect storm like this one. While management could continue paying the dividend, it's increasingly possible that the company may choose not to for a period of time in order to be conservative...
Overall, we believe Disney remains an attractive business despite these short-term uncertainties. The company's brands, unique assets, and long-term earning power arguably haven't changed, and its balance sheet remains strong enough to get through this difficult period.
In other words, this isn't necessarily a reason to sell. Investors just need to be comfortable with Disney's unprecedented lack of visibility in the short term. We will continue monitoring the situation.
