Should You Buy Disney (DIS) Stock? 3 Pros, 3 Cons

Despite investor hand-wringing over ESPN, Disney’s (DIS) strong earnings this past quarter show a company that is in fine shape.

Should You Buy Disney Stock? 3 Pros, 3 Cons (DIS)DIS stock has been overseen by Robert Iger for quite some time, and Iger has repeatedly shown that he is totally on top of everything going on at the company.

So let’s look at what’s transpiring with Disney earnings (PDF) and determine if DIS stock is still worth owning or buying.

DIS Stock Pros

Cash Flow: Disney’s financials were strong again this quarter. Total revenues for DIS were up 9% over the year-ago period and 7% for the full fiscal year. Segment operating income grew 27% and 13% for the year. Both net income and operating cash flow for DIS stock were up 7% and up 12% for the year. You simply cannot stop a company that generates $6.64 billion in free cash flow on an annual basis. Just think about how large that number is and how much flexibility it gives Disney to grow organically or via acquisition.

Strong Segmentation: The segment breakouts demonstrate that everything in each individual division is going strong. Despite all the drama at ESPN, Disney’s cable network revenue for the quarter rose 12% and operating income jumped 30%. Revenues were up 10% for the year and operating income was up 5%. Heck, even ESPN’s affiliate and ad revenues rose, so I don’t see why everyone is complaining. Programming costs increased, but I don’t really care if the content is good. Because the entire travel sector is doing well, that spilled over into Parks & Resorts, which also saw strong increases. Price increases at some of the parks also went into effect. Disney’s brand gives it this pricing power; where else can you find people willing to stand in line for hours for a ride that lasts mere minutes and be happy to pay more money for the privilege?

Star Wars: Of course, the biggest pro is the upcoming release of Star Wars: Episode VII — The Force Awakens.  The trailer only has more than 50 million views on Alphabet’s (GOOG, GOOGL) YouTube, and the movie is expected to surpass $615 million on opening weekend. Couple that with merchandising and affiliate deals that have been in place for months, of which DIS stock is already the beneficiary of sales for that property, and the first quarter is shaping up to be a blockbuster.

DIS Stock Cons

ESPN Woes: Although ESPN is holding its own, there are some cracks in the operation. Three-hundred people lost their jobs recently. Disney’s new SEC football channel launched and did well, but without it, some of ESPN channels saw a subscriber decline and programming saw lower ratings. ESPN is going to have to transition to some other kind of model, but I’m not too worried. I can see lots of options, such as a la carte streaming of various games in various sports, for a fee. I will wager that the ESPN unit will buy at least one, if not more, major online “real money” fantasy football operations.

Struggling Interactive Division: The interactive division is still struggling. While segment operating income increased $13 million to $31 million, revenues fell $15 million to $347 million. The Disney Infinity platform is establishing a foothold, but it isn’t the big solution. This division needs some real visionary help.

Rising Costs: Finally, while Disney earnings are chugging along nicely, costs are rising across the board. This is a very capital intensive company. While there is ample cash flow, there is also the necessity for constant maintenance and improvement at all parks. Movies are only getting more expensive to make and raw materials are generally becoming more expensive, giving Disney earnings estimates a challenge to hit every quarter.

Bottom Line on DIS Stock

With Disney earnings hitting $8.38 billion, and DIS stock now worth $195 billion, the company trades at 24 times earnings. That’s very much on the high-end of valuation that I’ve ever seen.

With 12% net income growth, plus a 1.3% dividend, we get a nominal fair value price-to-earnings of 13.3. I assign a 10% premium for each of the following: brand name, cash on hand and FCF generation, taking fair value to a P/E ratio of 17.2 … well below the current price.

My feeling is to hold DIS stock if you have it, since it will remain a long-term winner, but I would not buy here.

As of this writing, Lawrence Meyers was long DIS stock.

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