An 'Inside Out' Look at Disney

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Aug 10, 2015

Disney: (NYSE: DIS)

Last year I had written an article on MasterCard (MA), and the stock is up 27% since my writeup. This year I find Disney very attractive, and it was a mistake that I did not look at Disney last year.

The Business:

The Walt Disney Company, together with its subsidiaries, is a diversified worldwide entertainment company with operations in five business segments: Media Networks, Parks and Resorts, Studio Entertainment, Consumer Products and Interactive. In simple terms the cable network part of Disney owns ABCDE (ABC Network, Disney Channels, and ESPN).

“All I want to know is where I’m going to die and I’ll never go there” – Charlie Munger (Trades, Portfolio)

“Always observe the rule of not letting the hypothesis determine the story” – Warren Buffett (Trades, Portfolio)

Keeping in mind Munger and Buffett’s advice, let’s first look at all the negatives of owning Disney and how you would lose money if any by investing in Disney. This would save readers time and they can stop reading if they are not comfortable with the negatives. It also helps me to keep my bullish views in check while doing my analysis.

  1. Missed revenue estimate for Q3 2015 by $10 million. Slowdown in sales growth a concern.
  2. Will lose around $500mil of operating profit on strong dollar versus other currencies.
  3. Losing cable customers to online alternatives like Netflix.
  4. Lost some ESPN viewership and did not specify by what number.
  5. Revenue growing at single digit and in future can be even less if the movies in pipeline don’t make money. What if much hyped star wars does not live up to the expectations?

Let’s now look at other aspects.

The story so far

$1,000 invested in Disney in 2010 would be worth $3,175 today; that’s a CAGR of 26% for 5 years. The same amount invested in 2012 would be worth $2,197, or a CAGR of ~30% for last 3 years.

Stock price movement over the years 3years 5 years
Price as on Date 08/07/2015 08/02/2012 08/02/2010
$109.35 $49.98 $34.48
CAGR 30% 26%
$1000 invested would have grown to
1,000 $2,197 $3,175

Here is how they did it as per 2014 Annual Report:

We’ve reached this level of sustained success by focusing on three strategic priorities that unlock the limitless potential of this remarkable company: unparalleled creativity, innovative technology, and global expansion. Since embracing this strategy nine years ago, Disney has delivered some of the world’s most extraordinary entertainment experiences as well as significant growth and a total shareholder return of 317%.

Financials:

A look at the key numbers below shows how strong Disney’s financials are.

CMP 109.35
Market Capitalization 185.56B
Sales 50.71B
EPS 4.65(ttm)
PE 23.34
Book Value 27.10
Total Yearly Dividend Per share 1.32
Approximate Payout Ratio 24.50%
ROE 17.80
Sustainable growth [(RoE (1- payout ratio)} 13,43%
Dividend Yield 1.22%
Total Cash 3.74B
Debt to Equity 0.32

Below is a look at the sales, profits, cash flow and other financial numbers for the last three years along with the CAGR. Free cash flow has grown at 14% for last 5 years and 23% for last 3 years.

CAGR 3 Years CAGR 5 Years
Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 2011-14 2010-15
Revenue 36,149 38,063 40,893 42,278 45,041 48,813 6% 6%
Gross profit 5,712 6,726 7,781 8,863 9,450 22,393 42% 31%
Operating income 5,205 6,456 7,726 8,763 9,236 11,400 14% 17%
EPS 1.76 2.03 2.52 3.13 3.38 4.26 19% 19%
Shareholder Equity 33,734 37,519 37,385 39,759 45,429 44,958 6% 6%
Dividend Amount 0.35 0.4 0.6 0.75 0.86 1.15 24% 27%
Free Cash flow 3,311 4,468 3,435 4,182 6,656 6,469 23% 14%

Fiscal year ends in September. USD in millions except per share data

Return On Equity 14.73 14.41 16.6
Return On Capital Employed (%) 11.18 11.02 12.5
Operating margin (%) 21 21 45.9
Gross profit margin (%) 20.7 20.5 23.4
Net profit margin (%) 13.44 13.62 15.37

Management:

The management has done a good job of capital allocation as can be seen by the return on equity and return on capital employed which have been around 15% and 11%, respectively. Also the management has deployed capital wisely as can be seen below looking at what I call the ABCDE uses of cash.

A: Acquisition

Disney has done a great job of acquiring very profitable companies like Pixar, Marvel and Lucas Films. Who would not like to be on the side of Finding Nemo, Iron Man and Star Wars?

From 2014 Annual Report:

The acquisitions of Pixar, Marvel, and Lucas film gave us more than an unprecedented portfolio of fantastic branded content. They also brought some incredibly innovative storytellers to Disney, who’ve served as catalysts to expand our creativity in new directions.

Since joining Disney, Marvel’s brand of storytelling has an unbroken record of success – the five movies we’ve distributed so far have averaged almost a billion each at the global box office, and we’ll bring you another 11 incredible stories over the next four years.

B) Buyback:

Number of shares outstanding has gone down from $2 Billion in 2005 to $1.7 Billion currently. Disney has bought back 15% of its shares outstanding in the last 10 years.

C) Cash:

The company has 3.74 Billion cash on its balance sheet currently. How about some cash for a rainy day or for expansion?

D) Dividends:

Disney pays out 24% of its earnings in dividend. The dividend amount has grown at a CAGR of 27% in last 5 years. The current yield is 1.22%.

E) Expansion:

Disney is expanding overseas into China with its new Shanghai Disneyland which is coming out in spring of 2016.

“We’re closer than ever to welcoming our first guests at our Shanghai Disney Resort. This resort is very meaningful to me personally; I’ve spent 15 years working with incredibly talented people to take it from an ambitious idea into what we believe will be one of the most spectacular Disney experiences yet and an important part of our future. It’s been thrilling to watch this extraordinary dream rise from the ground toward the sky. With each milestone in our progress it becomes even more evident that this resort will exceed even our wildest expectations. The castle alone is cause for awe. It’s the largest we’ve ever built and, having seen it up close, I can tell you the size and majesty is truly breathtaking. And that’s just one single element in what will be one of the most artistically and technologically complex resorts we’ve ever created.” Bob Iger on the new Disneyland in 2014 Annual Report.

The Future:

Let us look at where Disney will make money in the future.

  1. Shanghai Disneyland: The new Disneyland has got tremendous response from the Chinese where in over 150 million people have expressed their interest via social media.
  2. New movies in pipeline- The biggest one is the Star Wars, the trailer itself has over 57 Million views on YouTube in last three months since the video was uploaded. I’ve put up an exhaustive list of movies in pipeline at the bottom.
  3. Partnering with Netflix to produce original content. Marvel deal is one example. Disney views Netflix as a friend and not foe and has partnered with Netflix to sell content on its platform.
  4. Disney has some good movies coming up in India thru its UTV productions. Not sure how much of that would contribute to the bottom line, but India is not a market to be ignored. In India we are now seeing for the first time movies making $100million in revenue.
  5. Growth from existing consumer products where it will increase sales by leveraging Star Wars franchise.

Most investors are treating as though ESPN is the only part of Disney. It Is true that ESPN's contribution to the bottom line is significant, but Disney can leverage its portfolio of strong franchises and partnership with Netflix and other acquisitions to increase sales. Also investors are worried saying online alternatives like Netflix are taking away from cable TV. The following statement from Disney’s 2014 AR should put to rest some of those fears.

One of the reasons I’ve always loved the media and entertainment business is because it is constantly evolving, influencing the world as it redefines itself with each new advance in technology. It’s what first drew me to ABC, and what keeps me even more engaged and enthusiastic 40 years later. In fact, there has been more transformational change in the last five years than in the first 35 years of my career combined.

We’re successfully navigating this rapid evolution because we decided early on to embrace technology and the disruptive change it brings as an opportunity for growth rather than a threat. As a result, we’re driving change on a number of fronts, adopting and developing technology that inspires creativity and empowers storytellers to dream bigger. They, in turn challenge our technologists to push beyond what’s possible today and unleash even more creative potential, allowing us to create a future unlimited by anything other than our own imagination.

Movies in Pipeline: Following list is from the 2014 Annual Report

Movie Year
The Good Dinosaur 2015
Star Wars: The Force Awakens. 2015
Finding Dory 2016
Zootopia 2016
Toy Story 2016
Captain America 2016
Doctor Strange 2016
Thor: Ragnarok 2017
Guardians of the Galaxy 2017
Black Panther 2017
Star Wars: Episode VIII 2017
Captain Marvel 2018
Inhumans 2018
Avengers: Infinity War (Part I) 2018
Avengers: Infinity War Part II 2019
Star Wards:Episode IX 2019

Final thoughts:

In last three years the earnings have grown at a CAGR of 19%. If we consider a conservative estimate of 19% forward EPS growth rate and a PE of 23 and assuming all goes well and the company earns $24 EPS at the end of next 10 years, then I believe the stock should be worth $138, which gives us a return of 26% from the current price.

If we consider a bullish case and give a 24% earnings growth and assuming the stock gets rerated with a PE value of 26. In such a case we can expect an EPS of $32 at the end of 10years. The stock should be worth $192. That’s a return of 76% from current price.

My two year old has already started saying “Good Dinosaur” whenever he sees a toy dinosaur, after having only watched the trailer few times. I am long the company that can bring a smile on my kids face. My money is on Disney and my views are biased. Please do your own due diligence. Thanks for reading.