(By Cristiano Bellavitis and Ben Roberts, portfolio manager and analyst of Integer Investments)
Disney (DIS, Financial) is one of the best brands in the world and has grown significantly over the past two decades, transforming itself from a minor film studio to one of the largest multimedia conglomerates.
The company recently announced a shift toward direct-to-consumer distribution and is planning to launch an ESPN-branded streaming platform in 2018 and a Disney-branded platform in 2019. The company also held now abandoned talks with 21st Century Fox (FOXA, Financial) about buying a portion of its assets that would further add to Disney’s IP library. On Nov. 9, Disney will release its fourth-quarter earnings report. Below, we will discuss what to look for in the earnings results and the implications of any surprises.
Disney, together with its subsidiaries, is a diversified worldwide entertainment company with operations in four business segments. It provides entertainment services aimed at multiple consumer segments but places emphasis on its "family friendly" brand. The company’s Media Networks segment contains ABC Television Group (ABC Network, Freeform, A+E Networks [50%], Vice Media [20%], Disney Channels, ESPN [80%] and Hulu [30%]). Parks and Resorts owns and operates Disney-branded theme parks and resorts with both domestic and international operations including Walt Disney World Florida, Disneyland Resort California, Disney Cruise Line and resorts in Paris, Hong Kong and Shanghai. The Studio Entertainment segment produces and acquires live-action and animated motion pictures, direct-to-video content, musical recordings and live stage plays. Films are produced under several banners:
- Walt Disney Pictures.
- Lucasfilm (includes Industrial Light & Magic).
Consumer Products & Interactive Media licenses the Disney’s intellectual property. The company also develops and publishes games, primarily for mobile platforms, and distributes branded merchandise.
In its latest earnings report, Disney shares fell 4% as revenue missed expectations, and there were renewed concerns about ESPN’s contribution to declines in operating income. It reported adjusted EPS of $1.58 vs. $1.55 expected and revenue of $14.24 billion vs. $14.42 billion expected.
Earnings unlikely to beat
Analysts have produced several estimates of what to expect from the upcoming fourth-quarter earnings release. According to Zacks Investment Research, consensus earnings are expected to be $1.12 while the most accurate estimate is $1.14. Currently the stock carries a Zacks rank 4 (Sell) and an ESP (Expected Surprise Prediction) of 1.49%; even though the ESP is positive, earnings are unlikely to beat. This is in line with our own expectations as macroeconomics factors over the fourth quarter were not in Disney’s favor.
Factors to consider this quarter
In the past several quarters, the strength of Disney’s Studio Entertainment and Parks and Resorts segments have impressed investors, but greater emphasis has been placed on the weakness of ESPN.
For Studio Entertainment, the fourth quarter is usually one of the weaker quarters for the company. This quarter, Buena Vista had no major releases thus revenues will be much lower than expected, but revenue from successful second-quarter releases such as "Guardians of the Galaxy 2," "Pirates of the Caribbean," "Cars 3" are likely to be recognized. The weakness of this quarter should not be an issue given the the weak performance of releases in fourth-quarter fiscal 2016, thus earnings will be flat or suffer a slight decline.
While Parks and Resorts has had robust earnings through the third quarter, we expect revenue and earnings to be lower than expected due to the impact of Hurricane Irma on DisneyWorld Resort Florida and Disney's cruise line service. The hurricane caused both cancellations of existing reservations and the closure of the Orlando theme park. This should only have a temporary earnings effect as we described the segment's long-term outlook in our previous article:
Disney has also recently begun work on a numerous expansions and refurbishments of its domestic parks including the expansion of its core brands ("Star Wars," "Marvel") into both the Orlando and California operations, we believe this should help to drive long term growth in attendance numbers and average spending per attendee.
Disney is focused on the expansion of Parks and Resorts, and these efforts will create long-term growth opportunities. Parks and Resorts alone will see significant revenue growth and margin expansion in the short term mainly as a result of Disney’s surge pricing initiative.
On the other hand, ESPN will still be a drag on the company’s bottom line and we expect subscriber losses to continue. Investors should be worried about ESPN’s short-term weakness, but with the launch of the ESPN streaming service in 2018, this should offset most of the revenue declines. Another concern for the Media Networks segment is the cord-cutting trend, falling subscriber numbers across all networks is expected and will have an adverse effect on earnings. Guidance will also be affected by increased operating costs associated with the acquisition of BAMTech and impacted by favorable currency fluctuations over the period.
Disney is expected to report revenues of $13.15 billion and earnings of $1.16 (source: Zacks). This is practically in line with the previous fiscal year. But investors' focus should be placed on across-the-board subscriber numbers. Regardless of the strength of other segments, analyst emphasis on ESPN will drag the stock price lower. We remain upbeat on long-term outlook given the strong fiscal 2018 film release schedule, potential of streaming services and the continued growth of Parks and Resorts. We like Disney at the current price of $101.18 and would add to our position if the price declines further.
Disclosure: Long Disney.