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February 06, 2008

Disney Proving Skeptics Wrong

Disney reported an exceptional quarter. EPS of 63 cents and revenues of $10.45 billion crushed estimates of 52 cents and $10.04 billion. Revenue growth was 9% and operating income gained 15% vs. expectations of 3%. Non-recurring items contributed no more than 2 cents to the EPS number.

On the conference call, management indicated that so far they see no signs of the economy causing a slowdown. Management pointed specifically to the fact that room bookings for the March through September quarters are running modestly ahead of last year. Given the fair argument that families don’t usually cancel vacations once they are booked, it seems that the near-term worries about Disney's theme parks are unwarranted.

In fact, I think a strong argument can be made that FY08 ending in September is pretty much in bag as a decent growth year well ahead of the outlook implied by recent estimate cuts. The debate is now going to shift to FY2009 where comparisons just got tougher and theme parks could come under pressure due to unwilling ness to book vacations based on current economic conditions and headlines.

Disney has incredible creative momentum. Hannah Montana, High School Musical, Cars, Pirates of the Caribbean, new hit shows on ABC, new sports rights at ESPN, the Jonas Brothers, Club Penguin, Enchanted. Each of these properties is driving current revenue. New properties are regularly created and old properties are revived and extended. For example, Toy Story did $400 million n retail merchandise sales in 2007. In 2009, the two original Toy Story films will be re-released in 3-D ahead of the 2010 release of Toy Story 3 and a whole new merchandising push.

Along with the revenue push from creative content, Disney is very tightly managed. Margins were very good in every segment except for the studio which faced an adverse mix shift from DVDs to box office.

Ultimately, the outlook for Disney comes down to a battle between the momentum of creative content and tight cost controls vs. a weakening economy. I think it is clear that at least for the next quarter or two Disney is very well positioned to weather the economic storm. On that basis the shares look modestly undervalued for the short-term and exceptionally undervalued for the long-term assuming the economy recovers in the second half of 2008.

Here are brief segment highlights….

Broadcasting: Revenues and operating income grew 8% and 30% against expectations of 4% and 14%. The writer's strike had no material impact. Strong advertising trends and elimination of mobile losses provided a boost.

Cable Networks: ABC Family and the Disney Channel were highlighted. ESPN grew as well although growth was held back by a higher revenue deferral than a year ago. ESPN ad revs grew by double digits.

Studio Entertainment: DVD sales fell 9% which is actually not bad and better than some estimates based on published sell through data. Box office was flat. Mix shifted in favor of box office which pressured margins. The Ratatouille DVD will not be released internationally until later this quarter. This could provide a nice bump to the March quarter given that over 2/3rds of box office was earned abroad making it the #2 international Pixar film.

Theme Parks: Attendance, spending, hotel occupancy, and margins were all exceptional. As outlined above, no weakness evident yet. The rest of the fiscal year looks good. On the call, management noted that the mix in the domestic theme parks has shifted toward the cruise and vacation club businesses. Cruises are in growth mode and the vacation club is holding up very well. In addition, management noted that it has "considerable leeway" to adjust cost to demand should demand weaken or strengthen. Items pointed include park hours and entertainment offerings.

Consumer Products: Revenues grew 26% and operating income grew 37% against estimates of 12% for both. While legacy content like Cars and Toy Story was very good, this performance can be directly attributed to Hannah Montana and High School Musical in merchandising and video games. In an aside, Bob Iger noted that girls are playing more video games which works to Disney's benefit. The decision to bring video games in house looks like a smart one.

Posted by Steve Birenberg at February 6, 2008 11:18 AM in DIS