Disney’s Growth Initiatives Pay Off


Disney [DIS] reported impressive Q3 2012 earnings this week.  While I don’t usually write about individual investments that I own, I felt that Disney deserved some mention this time.  Segment operating income was up 18%, while EPS was up 31% to $1.01, year over year.  This was driven pretty much by all of the company’s segments.

 

Business Segment Performance

Of special note, was the turnaround of the studio segment.  The unlocking of value from the Marvel acquisition was quite evident in the bottom line than ever before, with the film The Avengers.  However, the film is more than just a success at the box office.  More importantly, it marks the success and culmination of years of strategic planning & execution, turning Marvel into a major growth platform for the company (much like Pixar is).  As an investor who places a large emphasis on strategic planning and patient execution, it’s something I can appreciate.   The results this quarter is perhaps validation of their strategic planning.

The Avengers, was the headline news for Disney this quarter, but in Q4 the movie’s DVD release (September 2012) will continue to contribute to results, as will related consumer product sales, video games, and television revenues.  During the past quarter, the company also released the animated movie Brave, which was the 13th Disney-Pixar film.  It has yet to be released in some oversea markets, and those results will add to Q4’s earnings. For those of you who don’t remember, Pixar was acquired by Disney in 2006 to spur its then sputtering internal growth.  Today, Pixar is as deeply rooted in Disney’s culture as Disney’s is in Pixar.

Also overshadowed by Avengers were The Disney Channel and Disney XD, which have performed well in the quarter with very high ratings.  The Disney Channel was the number one network in the 2 to 11 year old as well as 9 to 14 year old range.  Disney XD, which had only launched in 2009, also saw its highest rated third quarter in the 6 to 11 year old and 9 to 14 year old range.  The company also saw the launch of its new Disney Junior network.  One of the company’s most consistently profitable networks, ESPN, saw its operating income decline in the quarter compared to last year due to deferred affiliate revenue.  But the timing of revnue recognition wouldn’t have any impact on its full year results.  Programming and production costs were higher at ESPN, but ad revenue rose by mid-teen percentage points compared to last year.  The increase was due to higher rates, unit sales, and ratings.  Ad revenue at ABC declined by lower ratings which offset higher CPMs.

One of the major areas of growth this year has been the Parks & Resorts segment, which delivered strong results.  Revenue increased 9% and operating income increased 21%. The increase in operating income was due to the growth from the Tokyo Disney Resort, the opening of Cars Land (California resort), and the launch of the Disney Fantasy at Disney Cruise Line (which is less known to many).  The Disney Fantasy is the second of two new cruise ships that were announced in 2007, the first of which was the Dream (maiden voyage in 2011). Of special note was a 38% increase in bookings at Disney Cruise Line, with 94% occupancy for the entire fleet.  Segment margins also improved during the third quarter.

There was continued progress in the Disney Interactive segment with lower operating costs in the quarter, due to improved results in the games business.  The Interactive segment which has been a drag on results for a long time, also saw improved results benefiting from social games. In 2010 Disney acquired social games developer Playdom, which created some of the most popular social games. Though management expects Q4 results to be comparable to last year due to the lack of comparable console titles to the successful Cars2 and LEGO Pirates last year.


Capital Expenditures in China

With respect to capital expenditure and new projects, the largest is on the Shanghai project.  China’s economy looks closer and closer to experiencing a hard landing, and the red flags are out there.  Corporate debt in China has climbed to 107% of GDP, credit guarantors have closed down in record numbers, pension funds have lost billions RMB, corporate losses have risen, and defaults have climbed.  Though China’s economic slowdown is of concern, only 43% of the Shanghai project is Disney’s.  In addition, capital expenditure will continue to drop moving forward.

Though Disney is not in it for the short term, they are building long term value and growth for decades to come.  There were similar concerns that the US financial crisis would specifically impact Disney’s consumer products and parks & resorts.  Indeed they did, and revenues along with profits dipped.  As the US economy recovered from the crisis (not yet fully), revenues along with profits rose.  When China’s economy experiences a credit crisis, it too will only be a bump in the road for Disney along with other quality companies.  But over the long run it won’t be a major problem.

 

Successful Leveraging of Assets & Long Term Strategic Planning

Disney remains one of the most sucessful (if not the most successful) companies in terms of leveraging their assets across all business segments, from consumer products, to resorts & parks, to video games, etc.  They also have long term growth visions for all segments, including their older & long established media network businesses.

In the last five years under current CEO, Robert Iger, Disney has really revamped themselves and established solid growth platforms across the entire company.  Most of those growth platforms are only now showing up in the headline earnings in a big way. Disney was out of favor a few years back, but anyone closely following the company and listening in on conference calls could have seen where they were heading.  With the less talked about UTV acquisition, launch of their Hawaiian resort, expansion of the Florida parks, partnerships with foreign animation artists, etc, there is still a lot of growth that will be added to future results.

What I like best about Disney, is that the executive team has done a great job of being conservative & smart about the investments they make, and when they do make mistakes (John Carter) they quickly acknowledge and learn from it.  They focus on generating higher returns, but without restricting the creativity of their teams or their ability to produce wonderful products & services. That is perhaps why the company enjoys ich a wide moat and sustainable competitive advantage.

 

Walt Disney Co Stock

The Stock is hitting 52 week highs, but does it mean that it is overvalued? No, it is still trading below its intrinsic value.  But it is definitely less of a bargain than it was a few years ago. Is it too late to buy?  I don’t believe so, as I still feel it is undervalued.  Though how large a margin of safety you want will differ from investor to investor, and should be considered.  It also doesn’t mean that you won’t able to get better pricing going forward, as Mr Market is unpredictable and may give investors cheaper pricing tomorrow.

With all the BUY recommendations out there now, should you buy it?  If it fits your plan and the price is right it may be worth considering.  However, you should never buy a stock that you aren’t willing to hold for years. And its always better to buy at severely depressed values, before everyone sees the big turnaorund in the results (can’t be ignored forever) or issue BUY recommendations, which usually results in price appreciation and the disappearance of that discount.

 

SEC Filing: http://www.sec.gov/Archives/edgar/data/1001039/000119312512341212/d359890d10q.htm

DISCLAIMER: I am long Disney.  I do not plan to add to or reduce my position in the next 9 trading days.

Thanks & Happy Investing! — The Investment Blogger © 2012

Author: The Investment Blogger

I’m a private investor based out of Canada, who developed the “function-centric investing” paradigm. I am an investor who blogs a little here and there, rather than a blogger who invests a little here and there. I'm passionate about investing and sharing investment knowledge!

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2 Comments

  1. Great article.

    I agree that Disney is an excellent investment choice, and as you point out the Marvel acquisition is starting to pay dividends, with plenty of strong titles in the coming months and years that will add to the bottom line in a big way. In addition to that, recovery from the recession will only help Disney, especially in their already flourishing parks.

    At what price point do you consider Disney as overvalued?

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  2. I usually don’t share my estimates of intrinsic value for companies, as I make very specific assumptions that greatly affect my estimate versus another investor’s estimate.

    That being said, my conservative opinion of their enterprise value is that the company is worth more than $100B. How much more exactly I’m not going to say, as again I could be wrong based on the assumptions I made. But $100B translates to a value higher than $55/share. Though, once you get to $55 the discount will be substantially reduced and so will your margin of safety.

    So when doing your intrinsic value calc on Disney, and you are really far above $100B (like $170B or something) then perhaps its good to rethink some of your assumptions. Its better to be more conservative than not. But you still have to try and incorporate what they are able to realistically achieve (positive and not just negative). That balance is always tricky.

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