- Disney experienced heavy losses in ESPN again this quarter but the stock price hasn't followed suit and has actually rallied.
- I still like Disney as a long due to its numerous competitive advantages that protect the downside.
- Risk management is key. Buying "in-the-money" calls or call spreads significantly reduces one's risk while waiting for the stock to rise.
Walt Disney (NYSE:DIS) announced its fiscal Q4 earnings on the 10th of November and the company missed on both the top and bottom lines. The company brought in adjusted earnings of $1.10 on revenues of $13.14 billion which were around 5% and 3% below what analysts had expected for the quarter. However, the stock didn't sell off in the after-market like many had expected and actually finished up 3%. This is interesting, as the Street always has valued this stock mainly off its media division which again declined in the fourth quarter (3%). However, the stock seemed to form a hard bottom last month and those lows at just above $90 a share is still holding.
Long term Disney investors will know that the studios and parks side of its business is cyclical. 2016 has been a bumper year with films such as Star Wars : The Force Awakens and Finding Dory but Disney has cautioned shareholders that 2017 will be lean in comparison. In fact, it won't be just a leaner film lineup but also higher ESPN fees (NBA Contract) that will eat into profits in 2017. Could this have been another reason why the market was keeping a lid on the share price this year? Long-term investors won't be distracted by temporary earnings adjustments. It's all about the fundamentals and buying at the cheapest valuation possible and we just may have that set up right here.
Disney's Losses In ESPN Will Eventually Subside
When I analyze an investment, I always look at the fundamentals first. I have written recently that when you take into account earnings growth, valuation, margin growth and strong competitive advantages, Disney as a long term play really stacks up. The "fear" is that its ESPN subscriber base is going to fall off a cliff which I can't see happening. In fact, Disney has already pivoted by buying Bamtech which will stream the new "ESPN" over the top which will be the future. Rights fees are going nowhere. The underlying issue is, in the way this content will be consumed in years to come, and I believe Disney will get a handle on how this part of its business is changing at present.
Disney's Downside Is Protected Due To Numerous Competitive Advantages
Nevertheless, for argument's sake, let's say Disney doesn't get a handle on its ESPN losses and continues to report losses in subscriber numbers over time. What an investor should do then? That very question usually is the wake-up call needed (the what if question) to thoroughly research the stock before pulling the trigger. In my opinion, here is what Disney has currently going for it from a fundamental perspective. The more competitive advantages a company has, the harder it is to see a huge sell-off in the stock. Investors will always by nature hold onto their perceived strongest positions and Disney, in my opinion, has an array of competitive advantages.
|Competitive Advantage||Why Is This Important?|
|Sustained Increase In Margins||Disney has more than tripled its gross margins over the past 10 years. This illustrates the pricing power it is able to garner in the market place. With present gross margins now approaching 50%, this states to me that charging premium prices especially at its parks (for example) will remain highly probable.|
|More Blockbuster Films Will lead To More Long Term Value||Many analysts simply look at what the studios division brings in every quarter from each individual film. However, the real value here is on the back-end as Disney can leverage its front end work by creating as many products and experiences from the franchises it works with. This is where again the parks come in. Therefore, the bumper revenues in studios this year will eventually be seen as meaningful gains at its parks and resorts.|
|Dividend||Payout ratio is only 25%. Debt to equity ratio is only 0.34 and projected long-term annual earnings growth of 9% a year. These are the type of numbers that really interest value investors especially as the company has a current earnings multiple of 17 which is well below its historic averages.|
Risk Management Is Key
The final piece of the jigsaw is risk management. Many sophisticated investors buy call options and call spreads to give themselves a better risk reward setup for the capital they put to work. For example, buying 100 shares of Disney presently costs well over $9,000 but simply buying the Jan19-$50 call costs half this amount although the investor still controls the same number of shares. Furthermore, this call option has a delta of 1 meaning its price will move at the exact same rate as the stock plus the share price has, more than 2 years to make its move. The end result is that one has less capital at risk here and a better risk/reward set-up which is advantageous for long term gains.
Disney ticks all the boxes when it comes to being an undervalued established company which is growing its earnings. The stock has numerous competitive advantages which include projected margin and earnings growth over the next few years. The risk/reward setup here is definitely bullish in my opinion and investors can skew this bullish setup even more in their favor by buying deep in the money call options which requires far less capital.
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