Disney Does It Again

By Stephen D. Simpson, CFA | May 08, 2013 AAA

As I said in my last write-up of Disney (NYSE:DIS), there's an element of predictable unpredictability to this company and that came through again this quarter. Like so many other consumer-oriented stocks, though, Disney has been on an absolute tear – more than doubling the performance of the S&P 500 over the past year. While I wouldn't worry about that if I were a long-term holder of Disney (and still planning on being one), valuation is making it appear as though there's a housing bubble for the House of the Mouse.

Studios And Parks Drive A Sharp Rebound In Profits
This was a very solid quarter for Disney. Revenue rose 10% and slightly surpassed the average Wall Street estimate. Growth was led by the parks/resorts business (up 14%) and the studio/consumer business (up 13%), while interactive (up 8%) and networks (up 6%) were hardly shameful.

Profits also came in better than expected, and by a wider margin. Operating income rose 30% atop a 29% increase in segment income, drive a better than three and a half point improvement in margin. Segment income outdid expectations by about 6%, with parks/resort income up 73%, studio/consumer income up almost 400%, and network margins improving (as income rose 8%).

SEE: Zooming In On Net Operating Income

Should This Have Been Such A Surprise?
I'm puzzled by the extent to which sell-side analysts are talking up the positive surprise at Disney relative to their estimates for this quarter. While I don't mean to cast aspirations on a solid quarter for Disney, it does make me wonder a bit about the analysts.

U.S. park and resort revenue was up 15% on a 8% increase in attendance, and margins benefited greatly from that increased through-put. Here's the thing, though – a big chunk of this improvement was due to the timing of New Year's and Easter, and it's not like the calendar is a big secret or anything. Likewise, the improvement in the studio/consumer business doesn't seem so surprising – the company was moving on from the John Carter mess and movies like Wreck It Ralph and Oz The Great And Powerful have been doing well.

More Opportunities For Disney To Be Disney
One of the things that really impresses me about Disney, at least in the resorts/park business, is the commitment to quality and the visitor experience. Six Flags (NYSE:SIX) and Cedar Fair's (NYSE:FUN) regional attractions are all well and good, and Comcast (Nasdaq:CMCSA) has a solid asset with Universal Parks & Resorts, but Disney is a cut above.

Given the recent issues with Carnival's (NYSE:CCL) much-publicized poo cruise, I think Disney can do even more. The company's cruise fleet is pretty tiny next to Carnival and Royal Caribbean (NYSE:RCL), and Disney has historically never been too shy about investing the capital today to garner more revenue tomorrow. Although the margins in the parks/resort business aren't all that great, the cash-on-cash return is better than you might think.

SEE: Walt Disney: How Entertainment Became An Empire

I believe Disney could also have opportunities to readjust its media exposure. As Citi's analyst Jason Bazinet highlighted a couple of months ago, the value of Disney's stake in A&E Television Networks (it owns 50%, with Hearst owning the other half) is likely worth about as much as Hearst's 20% stake in ESPN.

With Disney focusing more and more around core brands (essentially winnowing out the underperformers and really supporting the winners), it would make some sense to swap these assets. Said differently, I'd rather own 100% of SportsCenter and the broadcast rights to the NFL, NBA, NCAA, and MLB than 50% of “Duck Dynasty” and “Ancient Aliens”. Of course, a deal would almost certainly be predicated on Hearst's willingness to do the swap, and given Hearst's extensive diversification, they may not want to let go of their stake in ESPN without some extra inducement.

The Bottom Line
I have to admit that I was a little disappointed to see Disney license the right to develop Star Wars games to Electronic Arts (NYSE:EA), but it's hardly inconsistent with Disney's philosophy of really focusing on what they do well. What's more, it's a small quibble with what is otherwise a very solid business run for the long-term.

Even with that long-term focus, I'm not a buyer today. I've missed the big run in Disney, largely as I didn't think investors were going to bid up consumer stocks (particularly those with strong brands) so aggressively. Accordingly, whether by discounted cash flow or EV/EBITDA, Disney certainly doesn't look like an undervalued opportunity today. Were Disney to stumble (say, if the Lone Ranger movie flops) I'd happily reconsider, but above $60 it's hard to see this stock meeting my long-term return requirements for new buys.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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