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February 07, 2006

Disney Comes Through

Disney (DIS) reported better than expected earnings with EPS coing in at 35 cents against analyst estimates taht averaged 30 cents. Estimates will go up across the board with FY06 ending September heading toward $1.45-$1.50 from $1.41 presently. Furthermore, management spoke confidently about 2Q06 (the current quarter) and reiterated expectations for a strong back half of the fiscal year. Additionally, the forecast for double digit annual growth off the 2004 base through 2008 was reiterated. This forecast applies to the entire company. In Q&A, management was asked to confirm a similar forecast they have made about ESPN. They did so and noted that while they are promising "average annual growth" if there was going to a year where that was way off the trendline they would alert investors. This is comforting as it relates to ESPN next fiscal year where new sports contracts for NASCAR and Monday Night Football kick in. Analysts have been worried that this could lead to a flat or down year for ESPN. It is also comforting in that presumably the same theory about guidance applies to the entire company.

I still see DIS as the best large cap media stock. All of its divisions are moving in sync as the Studio should join broadcast television, cable networks, theme parks, and consumer products later this fiscal year. A multi-year forecast for double digit growth for a company with so many traditional media businesses is a strong endorsement of the outlook and should be rewarded with a higher stock price...

The conference call was very positive and showed that benefits could continue to accrue to the shares from the elevation of Bob Iger. The opening comments on the call were much briefer than usual, only about 20 minutes. The press release was just 14 pages, down from the mid 20s the last few quarters. Q&A was substantive and non-confrontational. Analysts showed Iger respect and asked good questions about long-term issues. Iger responded with a clear vision that DIS is a content company that is going to monetize its opportunities in new technologies and that is not afraid to challenge its current business models. It was refreshing talk that came across as honest and candid. I think analysts and investors will respond.

Looking more deeply at the quarter, Broadcast was very strong as the turnaround at ABC was stronger than expected. Furthermore, management noted that scatter pricing had accelerated from the 1Q pace into the "double digits" for the March quarter (scatter is purchase of ads for immediate showing as opposed to those that were previously reserved -- it shows the health of the current ad environment for ABC as it is selling current inventory at a premium).

Cable Networks look like they may have been a little weaker than expected even accounting for $105 million in deferred revenue not recognized at ESPN. Adding this back produces 9% revenue growth, still a slower rate than most of the recent quarters. The operating income comparison was negative due to the loss of the extremely high margin deferred revenues, investments at ABC Family, and investments in the ESPN Mobile telephony product. These investments will continue and the full year forecast for $130 million for ESPN Mobile is headed higher.

The Studio faced tough comps but the final figures, while still down significantly year-over-year look a bit better than feared. The Studio has always been a second half story for FY06 due to the timing of product last year and this year. For example, last Christmas saw The Incredibles and National Treasure in theatres vs. only Narnia this year. In the current quarter, The Incredibles was on DVD in the March quarter last year, while this year Narnia will hit shelves on April 4, in the June quarter. Finally, the two big releases from the company that are almost certain successes, Cars from Pixar and Pirates of the Caribbean hit theatres next summer and DVD next fall or winter. The company should have very easy Studio comps in the coming September and December quarters.

Theme Parks continued to kick out good growth with the top line rising 13% and operating income growing 51% as the margin expansion story continues. Attendance and per capita spending trends both were strong and management sounded confident about the outlook.

Consumer Products is a small division, less than 10% of revenue, but it produced a nice bump in operating income on flat sales due to the absence of North American Disney Stores. Looking ahead, comps get tougher in this division and the company will be absorbing an incremental $50 million in spending on its video game operations.

Finally, Iger made comments about Pixar and the Radio divestiture. On Pixar, the only major news was that the company was looking to move to two releases a year with the second release probably being a sequel. On Radio, management did not commit to using the cash proceeds for share buybacks but with the company’s aggressive and continually renewing program (fully diluted shares are down 100 million since the end of 2004), I think that is the logical use of cash. Responding to queries about using the proceeds towards an internet acquisition, Iger and CFO Tom Skaggs said they would do a deal if a good one presented itself but they gave up little information about what they might be considering, if anything.

Posted by Steve Birenberg at February 7, 2006 09:58 AM in DIS