The Fed just lowered interest rates. My top value stock to buy now.

In response to falling inflation and a weakening labor market, the Federal Reserve decided to cut its benchmark interest rate by 50 basis points for the first time in four years on September 18. Here’s why lower interest rates could help Walt Disney (DIS 0.85%) improve its profitability and meet shareholder expectations and why the value of the stock is a buy now.

Image source: Getty Images.

An unforgettable roller coaster

Disney launched its long-awaited streaming service, Disney+, in November 2019. Disney+ was meant to accelerate growth and provide a clear transition away from cable — which Disney refers to as linear networks.

The multifaceted approach to the parks, box office hits, Disney+, merchandise, and the still very profitable linear networks had the potential to propel Disney to new heights. And briefly, it did, as Disney stock hit an all-time high of more than $200 a share in early 2021, even as the COVID-19 pandemic took a sledgehammer to its parks business.

But behind the veil of euphoria on Wall Street were some serious problems, the first of which was Disney’s balance sheet. The company’s debt has skyrocketed to fund Disney+ and manage the pandemic-induced park slowdown. Even today, Disney’s long-term debt remains at high levels.

DIS Data Total Long-Term Net Debt (Quarterly) by YCharts

Disney had regularly returned capital to investors through buybacks and dividends. But in fiscal 2020, it stopped paying and reported its first net loss in more than 40 years. Investors have been willing to tolerate these red flags under extenuating circumstances, but there has been pressure for Disney to return to its pre-pandemic pace. Unfortunately, that didn’t happen.

Disney failed to deliver the box office hits investors were used to from franchises like Marvel and Star Wars. A flurry of content spending to grow Disney+ added to the losses.

In just a few years, Disney went from a reliable dividend stock to a company with rising debt, no dividends, declining earnings and negative growth. Disney recently reinstated its semi-annual dividend, but at a fraction of its previous level, as Disney only earns 1%.

Since returning as CEO in November 2022, Bob Iger has cut costs and led Disney to improved profitability. Iger and the rest of the management team doubled down on the parks, Disney’s real cash cow, and focused on content quality over quantity, which slowed the rate of theatrical releases and streaming content.

As a result of the efforts, Disney’s earnings have increased, and Disney+ achieved its long-awaited operating profit earlier this year, with expectations for even higher profits thanks to higher prices. Disney’s forward price-to-earnings ratio is now just 18.8 due to expected earnings growth and Disney’s low stock price.

Disney was up more than 30% year-to-date earlier this year, but has since given up nearly all of those gains. The company is now up just over 5% over the past 10 years, compared to a 190% gain in S&P 500 — highlighting what a poor investment Disney was.

Increase in consumer spending

When a stock underperforms by a wide margin for a long period of time, investors can (rightly) become skeptical of a lasting recovery. Along with the improved profitability of Disney’s streaming business, lower interest rates could be the catalyst the company needs to win back Wall Street’s favor.

From an operational perspective, lower interest rates will lower Disney’s cost of capital and may help it refinance debt or take on new debt at a lower price. More importantly, lower interest rates could boost consumer discretionary spending.

Disney is a textbook example of a cyclical business. When consumers are in good financial shape, they may decide to book a visit to a Disney park or cruise ship, see a movie in theaters or subscribe to Disney+, and the price increases to the stomach. But when consumer spending is down, expensive vacations and entertainment spending are cut back, which can lead to delayed vacations or an intolerance for price hikes in the stream.

Disney has undergone many cycles throughout its 100+ year history. However, business is fundamentally different today than it was in decades past. More than ever, Disney is relying on its wealth of intellectual property to drive loyalty.

The fanfare for the characters and stories of Disney’s past works are more important to driving park visitors than any new content they create. Similarly, access to Disney’s content library is a cornerstone of the value of a Disney+ subscription.

Disney has fallen pretty far

While lower interest rates could help Disney’s business turn around, it’s important to understand why the Fed is cutting interest rates in the first place.

Unemployment is rising and inflation is cooling. Credit card debt, mortgage interest rates and home prices are at high levels. Lower interest rates can boost economic growth and help consumers manage debt. But if lower interest rates lead to a return to high inflation and contribute to a recession, that could present even more challenges for companies like Disney.

Therefore, investors should only consider Disney stock if they agree with the company’s strategic direction, believe in the value of its intellectual property, and are willing to hold the stock during periods of volatility.