What do you do when a company forgets its annual dividend increase?

This is old news as it was reported in December, but I wanted to highlight a situation: Disney (DIS) didn’t increase its dividend as it usually does at that time of the year.  Management announced a bi-annual dividend of $0.88/share. Now, let’s be honest, you don’t buy shares of DIS to pay your utility bills every month (unless you can buy hundreds of shares!). But, the fact DIS didn’t increase its payout goes directly against my investment philosophy.

Disney its dividend growth policy

The Walt Disney Co owns the rights to some of the most globally recognized characters, from Mickey Mouse to Luke Skywalker. These characters and others are featured in several Disney theme parks around the world. Disney makes live-action and animated films under studios such as Pixar, Marvel, and Lucas Film and also operates media networks including ESPN and several TV production studios. Disney recently reorganized into four segments with one new segment: direct-to-consumer and international. The new segment includes the two announced OTT offerings, ESPN+ and the Disney SVOD service. The plan also combines two segments, parks and resorts and consumer products, into one. The media network’s group contains the U.S. cable channels and ABC. The studio segment holds the movie production assets.

Over the past 5 years, DIS almost doubled its distribution as dividend went from $0.86 annually to $0.88 every 6 months. With a payout ratio around 20%, DIS should keep its distribution in the high single to double digits for many years. Unfortunately, management didn’t increase its dividend as we expected in late 2019. The company has still lots of room to increase its payout going forward, but management may decide otherwise considering the amount of money required to market its new services. The good news is that it shows management can reward shareholders with better use of its money than dividends.

Why Disney didn’t increase its dividend?

What do you do when a company put its dividend growth policy on the shelf? I always say, “an absence of dividend growth is the first step toward a dividend cut”. The “no dividend growth policy” is part of the 3 Red Flags telling you it’s a bad stock. Does it mean I should get rid of DIS in my portfolio?

This is where investing gets so interesting: it’s never black or white. Looking at those red flags (high yield, no dividend growth and weak dividend triangle) will only create an opportunity for investigation. None of them creates a screaming sell. Let’s investigate Disney. The issue is quite easy to explain. First, the debt:

Sources: Ycharts

When Disney sealed the deal to purchase the Fox assets, the company disbursed $71B in the transaction. This is the kind of move that will most certainly increase their debt. Should you be worried? Let’s look at past Disney transactions:

• 1995: Disney buys Capital Cities/ABC and an 80% stake in ESPN in a $19B deal… ESPN became a growth vector for about a decade.
• 2001: Disney buys Fox Family Channel for $2.9B (we can see the link with their most recent acquisition).
• 2006: Disney buys Pixar for $7.4B. This was a transformational deal for the business.
• 2009: Disney buys Marvel for $4B. Have you looked at the top box office movies since then?
• 2012: Disney buys Lucasfilm for another $4B. The first movie racked over $2B in box office revenue. That was the deal of the decade.

source: Ycharts

When you look at Disney’s acquisition track record, you can see how each transaction has something in common: it adds content to Disney’s Empire. What Disney does best is they create multiple streams of income from its inventory of content.

The second reason why Disney didn’t increase its dividend is most likely because it wants to use its cash flow to grow its streaming services. With Disney + and ESPN + positioned as potential growth vectors, the world is looking at how management will make them another success story. You can expect money to go there for a while. I’m good with that idea. Between their two new streaming services and Hulu, Disney will become a very strong challenger (2^nd player) in the streaming space. As opposed to Netflix (NFLX), Disney enjoys other streams of income and has an incredible track record when it comes down to producing content.

No dividend increase – keep or sell?

After reviewing the possible reasons why Disney chose not to increase its dividend for 2020, I feel comfortable keeping my shares. According to financial theory, a company must pay a dividend to shareholders when it is running out of ideas to make its money grow faster within the business. I think management has just found a way to create a lot more value for us than increasing that 1.25% yield.

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Disclaimer: I hold shares of DIS