- Walt Disney's expectations seem modest despite the weak broadcast/cable environment.
- The top 3 performing movie franchises all belonged to Disney in Q1'16 and will likely drive a sales/earnings beat this quarter.
- The company is best positioned among media franchises to generate shareholder returns this year.
Getting a pulse for Walt Disney (NYSE:DIS) ahead of earnings is somewhat difficult, but sell side estimates seem extremely attainable as growth in sales/earnings is heavily concentrated in the studios/consumer products segment in FY’16. The strength of the film slate in FY’16, along with the carry-through of revenue from Star Wars the Force Awakens from Q4’15 into Q1’16 creates upwards momentum/bias going into the earnings report despite margin/subscription headwinds from Skinny bundles, which could cause pricing attrition, but is offset by some subscriber retention. Notwithstanding cord-cutting in the broadcast/cable segment, Disney’s portfolio is relatively robust with a broadly diversified revenue mix de-risking a scenario of rapidly declining subscriptions for conventional broadcast/cable media.
Source: RBC Capital Markets
As you can tell, Disney’s affiliate revenue makes for appx. 25% of total affiliate subscription revenue, i.e. the high concentration of Disney channels and the impact on pricing creates challenges to the investment thesis assuming fewer channels due to the exclusion of channels in smaller packages. i.e. Disney will struggle with sustaining $13-$15 in monthly subscription fees from its channels, as the market for conventional cable subscriptions shrinks, which creates some negative bias on revenue. But, given the slow uptake of skinny bundles, I view the threat of earnings/sale deterioration not as meaningful over the immediate timeframe but will become a bigger source of concern as we transition more to online-streaming formats in the 2020 timeframe.
Furthermore, Bog Iger (CEO of Walt-Disney) acknowledged technological obsolescence at the 2016 Deutsche Bank Media Conference:
The current analyst consensus estimate for Walt-Disney Q1 is $1.40 EPS and $13.21 billion revenue, which implies 13.82% y/y and 6.4% y/y growth respectively. Among major media franchises, it’s been noted that Walt-Disney trades at a premium, but I find that downside risk to valuation is mitigated by the staple of quality media properties, and sustained growth from the theme park business, which is where Disney concentrates its Capex, which has proven to be a great store of value on a ROIC basis (18.34% FY’15) and builds an asset buffer with total shareholder equity of $44.52 billion.
That being the case, the company’s enterprise value is a bit inflated, as it stands at $188.18 billion as of the most recent quarter, which is higher than the company’s actual market cap of $163 billion. The company’s intangibles are valued a lot higher, which creates risks in the event the economic cycle turns. In a trough cycle, the intangible components of valuation get further compressed, as financial securities tend to trade closer to mark-to-market or acquisition cost, i.e. tangible book.
Of course, I find near-term recession relatively improbable, so the downside risk to valuation is capped assuming stable macro policy by the Fed. Since I’m an avid Fed observer, I feel like recession risk can be discounted, which creates a strong bias for sustained earnings growth despite lumpiness of film slate and subscription churn. That being the case, investors should watch the cost/revenue ramp of the Shanghai Disney resort/park as it’s set to open in 2H’16, and is roughly 90% completed (as of the most recent Deutsche Bank media conference on March 8th 2016).
Furthermore, according to RBC Capital Market estimates, the parks and resorts segment is expected to grow sequentially by 8.9% and 3.2% in Q3’16 and Q4’16 respectively. Disneyland Shanghai is the largest park addition and is scheduled to open on June 16th 2016. This adds to top line growth in the back half of fiscal year 2016, as the Shanghai Park has a target market of 300 million+ Chinese visitors within a 3-hour travel radius given the rail infrastructure that’s built into the park. Furthermore, the park can accommodate high traffic given the sheer size, which implies higher incremental impact when compared to other major park openings.
Domestically and internationally prices will increase this year with varying tiers across domestic and foreign parks/resorts. In the parks and resorts segment, net-net pricing adds perhaps 3 to 5 percentage points of upside bias y/y, whereas Disney Shanghai will become the 6th theme park added to Disney’s portfolio. The average of 5 Disney Parks generated $3.23 billion in revenue in FY’15, and assuming demand is high in the initial year, I anticipate incremental revenue contribution of $1.615 billion due to the half-year contribution of Disney Shanghai and comparisons of full-performing parks.
So, when adding pricing impact of 4% for all domestic/international parks, and the incremental revenue from Disney Shanghai, I come away with revenue of appx. $18.42 billion, which is roughly a full billion dollars higher than RBC estimates. In other words, the consensus is extremely conservative on park revenue contribution in 2H’16, which creates a better environment for sales/earnings beats in the back half despite weakness in core advertising in the broadcast/cable segment.
On the movie front, initial checks on domestic movie screenings for Disney properties were positive by Wedbush Securities (at least domestically). Here are the figures for domestic screenings in Q1’16 when compared to Q1’15. The ticket revenue from domestic movie releases was roughly 28% higher among the top 10 franchises y/y of which Disney owned Dead Pool (Marvel studios), Star Wars: The Force Awakens (Lucas Films) and Zootopia (Disney Films). Basically, Disney owned and operated the top 3 performing movie franchises in Q1’16, which implies that Q1’16 revenue beat will be driven by the continued strength of the 2016 film slate.
Source: Wedbush Securities
When taking into consideration all of these qualitative/fundamental factors I believe investors should look to acquire positions ahead of Walt-Disney’s earnings announcement on May 10th 2016. The business seems solidly positioned to top estimates on both bottom and top line despite questionable implications from its cable and broadcast segment. Initial figures on skinny bundles aren’t so overwhelming that mix-shift to smaller bundles affects EPS by more than a couple points this year. Since the adoption of skinny bundles is coming from millennials some of the demand is incremental due to an a-la-carte model. Therefore, some incremental positives/negatives on the subscription front but plenty of upside in the remaining operating segments in the current FY drives my positive bias.
As such, I initiate my Walt-Disney coverage with a high conviction buy rating and will offer a price target following the earnings release.