A Little Noise In Disney Earnings Shouldn't Matter Much

By Stephen D. Simpson, CFA | August 07, 2013 AAA

Even though Disney (NYSE:DIS) shares were basically flat for the past quarter (while the S&P 500 was up about 5% and some consumer indices were a little stronger), it's hard to overlook the 30%-plus gain over the past year. Along similar lines, while the company's core cable, international park, and movie business may have not done so well this quarter, Disney doesn't run itself on a quarter by quarter basis. With that, and the company's strong sports, movie, park, and IP franchises, it's hard not to like Disney as a company, even though the shares don't look particularly cheap.

An Okay Quarter
Disney's valuation may magnify some of the questions about this fiscal third quarter, but the results were okay on balance.
Revenue rose 4% as reported, coming in just shy of expectations. Revenue growth was led by the theme park/resort business, where revenue rose 7% on good domestic attendance (up 3%) and spending (up 7%). Network revenue rose 5% (with cable up 8% and broadcasting down slightly), while studio revenue fell 2%. The smaller consumer and interactive media businesses were up 4% and down 7%, respectively.

Disney's profits were a bit more convoluted and this may generate a little more attention and concern. As reported, operating income rose 3% for the quarter and that was good for a slight beat relative to the average estimate. Segment profits were up 4% as reported, with networks up 8% and parks up 9%, while consumer was up 5% and studio profits plunged 36%. Profit growth was less impressive on an adjusted basis (taking deferrals and so on into account), though, with growth of less than 2% but analysts and investors may differ on how (or whether) to make those adjustments.

The Studio Business Is What It Is
I suspect that part of the weakness in Disney stock this past quarter can be tied to the very weak box office performance of the surprisingly expensive Lone Ranger movie. It sounds like the company will be taking a $160 million to $190 million writedown on this flop in the next quarter, though other movies like Iron Man 3 and Monsters University did alright.

This is just how the movie business works. Sony (NYSE:SNE), Time Warner (NYSE:TWX), and DreamWorks (NYSE:DWA) all have their hits and their flops. Although movie budget inflation would seem unsustainable, the rewards are still there for well-made movies that resonate with ticket-buyers. To that end, Disney should have plenty of material to mine for blockbusters across properties like Pixar, Marvel, and Lucasfilm.

Will Fox Offer Much Of A Threat?
21st Century Fox (NYSE: FOX) desperately would like you to think that its upcoming Fox Sports One launch will make the company a direct rival and threat to Disney's insanely lucrative ESPN sports franchise. I wouldn't hold my breath. There's definitely room in the market for more sports and I can't be the only person who suffers from “ESPN fatigue”, but there's a big difference between capturing an incremental couple of hours of viewership and changing the landscape.

Nevertheless, Comcast (Nasdaq:CMSCA) and 21st Century Fox are making it pretty clear that they're serious about trying to make a go of it in the sports world. More troubling for Disney long-term, though, may be the evolution away from cable and the growing “intensity” of negotiations between cable providers and network companies. For now there are far fewer streaming options for live sports, but I wouldn't be surprised if that's destined to change at some point over the next decade.

The Bottom Line
With new Star Wars movies coming down the road and the new Shanghai Disneyland park opening late in 2015, there are certainly some catalysts on the long-term horizon for Disney. But I think it's probably unproductive to look at Disney as a big catalyst stock – this is just a huge media and entertainment empire that year-in and year-out generates large cash flows.

I'm expecting long-term cash flow growth of around 10%, which supports a fair value of almost $62. The company's ROE/PBV also supports a similar valuation, so that's the point below which I'd start to get really interested in owning Disney. Buying a long-term story like Disney above apparent fair value isn't the worst decision in the world for long-term holders, but I'd hold out for a better price with my own money.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

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