- The Walt Disney Co. reported a bad quarter, but the weakness in results isn't likely to repeat.
- Future Results will be driven by political/Olympic coverage, international box office, Disney Shanghai, and strengthening advertising results.
- Furthermore, subscription revenue will likely stabilize given Nielsen C3 metrics, and lowered expectations going into 2H'16.
Admittedly, Walt Disney Co (NYSE:DIS) reported a miss on sales and earnings, which is uncommon but it also creates a compelling opportunity for growth/value oriented investors. Given the staple of quality franchises across its media, movie, consumer products and parks segment, I believe investors will make a U-Turn on their initial observations notwithstanding the miss on earnings/sales in the prior quarter.
Walt Disney reported sales of $12.87 billion and EPS of $1.36, which missed consensus by $220 million and $0.04 respectively. Again, I was pretty optimistic going into the quarter, and I believe part of the reason sales were weak had to do with the timing of costs, heightened expectations of cinema revenue, and the weakness in advertising revenue in its media segment. Of course, ratings on ABC weren’t particularly great, which negatively affected operating income, which declined 8% y/y. However, the ad-performance and affiliate revenue from purely the broadcasting segment performed above consensus. The cable network results drove the divergence from sell-side financial models, and since the sell-side is way more conservative than the buy side, it’s the distortion of market expectations that led to a massive drop in the stock price following the earnings report.
I also think there was a bit of a timing issue with regards to the Parks & Resorts segment. Management indicated that it could boost its pricing a little without negatively impacting park attendance. Basically, the execution on pricing for its parks & resorts segment was an issue this quarter, and I anticipate that the new pricing structure will eventually even out, but that’s more of a 2H’16 theme.
The company has yet to ramp its revenue from Walt Disney Shanghai, so I’m getting the feeling that recovery is mostly tied to Q4’16, as the fiscal year ends on October 3rd. So, with the park opening on June 16th, the y/y comparisons get significantly better in five months of the year, which reduces my upward bias from parks and resorts. However, the strength of the current film slate/studio entertainment performed above consensus. Notwithstanding there were some timing issues with regards to the revenues from that segment. Given its blockbuster results across more film titles this year when compared to last year, the y/y comparisons should have been stronger. It was basically Disney’s quarter at the box office, and it’s likely that global box office will materialize more fully in Q3’16 as opposed to Q2’16.
It will take some time to see additional franchises materialize in the form of merchandise sales, so I believe there’s a solid merchandising opportunity, but won’t get captured until we move into the holiday quarter of Q1’17. That being said, it’s going to take some time to recover, but given Disney’s strong record of management, it would be advisable to get aggressive on the recent dip. Of course, hindsight is always 20/20, but given the foreknowledge that q/q trends will likely pick-up, I’m thinking there’s a distinct opportunity that Disney will move higher in the remaining two quarters of the year, as earnings/sales estimates are more beatable due to:
- Timing of international box office receipts, the consensus anticipates q/q acceleration in the studio segment.
- Stabilizing Nielsen C3 metrics in media/cable from skinny bundles and better ad pricing.
- Opening of Disney Shanghai, with initial interest pointing to upside in traffic and pricing.
- Lowered expectations from investors and sell side, which will create heightened sentiment even if the sales/earnings beat proves to be modest.
- Lower contribution from cable in Q3’16, plus above seasonal trends in Q4’16 thus balancing poor 1H’16 performance and better timing of intersegment growth.
Entering the summer months, the cable network contributes less revenue (major league baseball season) and while I know MLB fans will despise me for saying this, but it’s the 3rd most watched sport among the major four (NFL, NBA, MLB and NHL). Therefore, the growth in some of the other segments can help mask the performance in decelerating cable/broadcast in Q3’16.
In Q4’16, a decent chunk of the Olympic games will be aired on ESPN internationally, so there’s upside in the form of international broadcast/cable in Q4’16. Also in Q4’16, the political election coverage starts to pick-up even greater momentum as the polls open on November 8th. So, we’ll see all of our favorite political correspondents tallying up the votes, as the states flicker red or blue (the usual tradition in the United States). So, the global and national event coverage in broadcast and cable keeps me optimistic. Basically, viewership metrics will tick significantly higher upon convergence of the quadrennial Rio de Janeiro Olympics and general presidential election.
Here was some key commentary on Nielsen metrics from UBS analyst Doug Mitchelson coming out of the quarter:
US Ad-supported cable network affiliate growth stabilized at 5.7% Y/Y, up slightly from 4Q15's 5.4%, halting the deceleration seen since 1Q15. Our 2Q roll up shows continued consistent growth at +5.2% Y/Y. Note, our pay TV subs tracking (traditional+ V-MVPDs), shows cord cutting in-line with the prior 3 qtrs. Further, we expect skinny bundle impacts are moderating, keeping overall cable network distribution trends stable (at -1.5% for most fully-distributed networks, -2.0% for those with sports).
Basically, the decline from cord-cutting and transition to skinny bundles is starting to stabilize. This makes me incrementally optimistic. If affiliate revenues stabilize, I believe the remaining segments will garner enough traction to drive above consensus results in future quarters.
The pricing on advertising is expected to recover in Q3 and Q4’16 according to Piper Jaffray analyst Stan Meyers:
Last year's delay in Upfront commitments ended the lengthy negotiations with $8.4B in ad sales, down 3.7% yoy. ABC in particular sold 72% of its inventory, down from 75% in the prior year, though CPMs increased roughly 5%. This year, based on our conversations with ad buyers, we expect ABC to sell more inventory, likely in the 75% range with pricing up in 5-6% range.
Walt Disney seems like a better investment given the backdrop of near-term events that will drive cable and broadcasting revenue. Within the space, I like it much more despite the sell-off following earnings. I would warn investors that it’s still worth holding at these lower levels, as it’s likely that results will balance out as we progress to the second half of the year due to higher advertising pricing, stabilizing subscription revenue, global box office receipts, opening of Disney Shanghai, and on-going election coverage. While I have yet to build a detailed model for Walt Disney, I will do so prior to Q3’16 earnings.
Furthermore, I continue to reiterate my buy recommendation. The mishap on earnings won’t repeat in the second half of 2016.