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February 03, 2006

Disney Earnings Preview: Last Slow Quarter Before Growth Accelerates

Disney (DIS) reports after the close on Monday. Due to timing issues and a tough comparison in home video, the quarter is expected to show a year-over-year decline in EPS and EBITDA. However, DIS is still poised for strong growth in its FY06 ending this coming September. I believe the back-end loaded year is well understood by investors but it does raise the stakes the in the remaining quarters which always is a yellow flag. As long as guidance for 2006 is maintained and the company stands by its "average of double digit growth through 2008" forecast, I think DIS shares are attractive and the best bet among large cap, diversified media stocks. Entering calendar 2006, DIS has all its major businesses moving in a positive direction at the same time and there is reason to believe that these trends are sustainable. I am long DIS across the enitre Northlake client base and in my personal accounts with all purchases made in the range of $24 to $26, including some as recently as late December.

For the December quarter, which is 1Q06 for DIS, the consensus EPS estimate is 30 cents vs. 34 cents a year ago. Revenue is forecast at $8.78 billion. For the March quarter, EPS are currently forecast to be flat at 31 cents vs. 32 cents a year ago. FY06 consensus EPS calls for $1.41 vs, $1.32 a year ago, representing a gain of 7%. Growth is expected to accelerate in FY06 with EPS rising to $1.63, up 15% against the current FY06 consensus....

There are going to be lots of changes to the company's financial statements due to the Pixar (PIXR) acquisition. The figures quoted above exclude PIXR. I am positive on the PIXR deal because I think that animation remains the driving force behind DIS's growth due to the flow-through of animated product to the company's theatrical, home video, theme park, and cable network divisions. I think the addition of PIXR is worth the dilution and the integration risks given the potential boost to the company's long-term growth rate from a revived animation division.

This quarter will also debut a change in DIS's financial reporting as the company is going to fold its equity interests in four cable networks into its operating segments. This should have no impact on the bottom line but it might impact growth rates at the Cable Networks segment level. Hopefully, the company will provide historical pro forma data. The four investments include 39.6% of E! and A&E, 37.5% of the History Channel, and 50% of Lifetime. There is a lot of value in these investments that is often overlooked by investors, maybe $2.5 billion at $20 per subscriber, or $1 per DIS share after-tax.

Broadcasting should be the star performer this quarter as the turnaround at ABC is in full bloom benefiting both the network and the owned and operated stations. The station also may have gotten a boost from political spending due to the New York City Mayor's race and the NJ Governor's race. Revenues are forecast to grow 15% with EBITDA up 90%.

Cable Networks faces a tough comparison due to timing issues. ESPN has to defer $100 million in revenue due to contracts with affiliates that require revenue recognition to coincide with airing of original programming. There may also be a timing issue related to the recognition of revenues and expenses related to the company's huge NFL rights package since the quarter incorporates most of the NFL season. Revenues are forecast to grow in the mid-single digits but since the deferred revenue carries virtually a 100% margin, EBITDA will decline by mid-to-upper single digits.

Theme Parks will continue their turnaround led by solid attendance trends at the domestic parks. Revenue for the combined domestic and international parks should grow in the upper single digits despite a negative comparison at the international parks. Ongoing margin expansion at the domestic parks should lead to growth of over 20% in EBITDA for the entire segment.

The Studio should report a profit this quarter after losing over $300 million last quarter. However, the big profits at the studio will occur in 2H06 and FY07 due to the success of Chicken Little and The Chronicles of Narnia: The Lion, The Witch, and The Wardrobe and the projected success of PIXR's Cars and the sequel to Pirates of the Caribbean both due in theatres next summer. Remember that it is the DVD sales that drive profitability of the Studio.

Consumer Products is DIS's smallest division but should shoud decent growth this quarter due to the benefits of the divestiture of the company's North American retail stores.

Posted by Steve Birenberg at February 3, 2006 01:06 PM in DIS