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August 09, 2006

Strong Quarter For Disney But 2007 Concerns Limit Upside - For Now

Disney (DIS) reported much better than expected 3Q06 EPS. EPS of 53 cents easily beat consensus of 44 cents (3Q EPS were aided by 1-2 cent accounting benefit). Revenues were only slightly better than expected so it was operating profit performance that provided the upside. In particular, the Studio, Theme Parks, and Consumer Products provided the upside. Cable Networks also had strong profit performance. The only weak spot was Broadcasting which came in lighter thane expected on revenues and profits.

The shares should respond well to this report although I expect the debate over the 2007 growth rate to continue. Management did not provide any guidance for 2007 but did offer a list of swing factors. On the plus side, the 1-2 punch of Cars and Pirates of the Caribbean: Dead Man’s Chest should drive profits throughout the company through FY07 and FY08. Importantly, these two properties show how DIS is able to leverage successful content throughout all of its divisions. High School Musical on the Disney Channel is another example that is driving current results through TV ratings, album sales, and book sales. Also on the plus side for 2007 is a decent upfront for ABC. If ratings meet guarantees, ABC has plenty of scatter to sell and lots of digital tie-ins to sell.

Potentially holding back growth in 2007 are tough comps at the Theme Parks, the uncertainty of ratings at ABC and ESPN, slower affiliate fee growth at ESPN, the struggling overall ad market, and significant investments in distribution for consumer products. It is also unclear how much investment will occur in the ESPN and Disney mobile telephone ventures.

In the short-term, I think investors will give DIS the benefit of the doubt given the outstanding results the company has achieved over the past several years, especially recently during Bob Iger’s brief reign. DIS is playing offense with a strong lineup. Investors should continue to applaud.

Looking a little more closely at the quarter….

Broadcasting suffered from heavy investment in new pilots and costs assoicatied with the Disney Mobile venture. Radio, which is being divested, was also weak, in line with industry trends. ABC and the stations performed OK otherwise.

Cable Networks saw slightly lower than expected revenues but great margin performance so that profits were at the very high end of expectations. ESPN is performing well and the Disney Channel is benefiting from the multi-platform success of High School Musical.

Theme Parks performed particularly well on margins with revenues at the high end of expectations. I was a little surprised that analysts were assuming flat or even lower margins despite consistent gains over the past few years. Marigns rose almost 200 basis points vs. a year ago. On the call, management expressed confidence in its ability to control costs in the future, providing some defense against the tough comps in theme park attendance. Occupancy in Florida and California is over 90% and per capita spending has been rising in the upper single digits.
The Studio was a blowout in the quarter. Revenues and operating profits beat expectations by at least $100 million. DVD sales for The Chronicles of Narnia. DVD units were up 9% with lower distribution costs and lower returns. This couldbe an indicating that DIS is getting its arms around the changes in the DVD market which have accompanied slower growth. Strong box office from Cars and lower costs at Miramax also helped the quarter. Higher costs for marketing of Cars and Pirates did hold back profits.

Consumer Products was very strong, with profits beating expectations by $20-30 million. Iger opened the call noting that Cars merchandise is incredibly strong with young boys and that Pirates may be the biggest cross platfrom success the company has ever had. Strength here should continue but will be offset by increased investment in distribution channels and video games.

Posted by Steve Birenberg at August 9, 2006 04:51 PM in DIS