The big story around Walt Disney Co (NYSE:DIS) this past year is how ESPN will transform, as subscriber loss has hit the companies most profitable division. Now we have some answers. I think Disney stock is headed into a transition period, while the ESPN situation sorts itself out, and that means a buying opportunity may be at hand.
The news was generally quite good for Disney stock in its Q2 earnings report. Overall revenues were up 9% to $14.277 billion, and up 9% for the first nine months to $42.49 billion. Operating income was up 8% and 13%, respectively, to $4.45 billion and $12.54 billion.
Net income, however, only squeaked up 5% to $2.597 billion. For the nine-month period, it was up 13% to $7.62 billion. Obviously, previous quarters were kinder to Disney stock.
So why the drag? Media networks. Revenues increased only 2% and operating income was essentially flat at $2.4 billion. That accounts for about 55% of the operating income for Disney stock. However, when you dig deeper, there is some good longer-term news hidden in there.
New Hope for Disney Stock?
ESPN actually showed an increase in advertising revenue, which was offset by higher programming costs.
Affiliate revenue growth was contractual and that was offset by subscriber loss and currency exchange losses. DIS also saw a higher equity loss from Hulu, as the service spent more money on programming. However, Hulu is launching original programming now, and when you look at its slate of content, it’s a genuine player in streaming that is growing.
The big news here is that DIS did buy a 33% stake in Major League Baseball advanced media streaming unit. That’s going to give ESPN a streaming platform, which I said would eventually occur. Now the tricky part begins; balancing streaming and cable revenue so one doesn’t cannibalize the other. I have faith that DIS management will figure this out, but it’s going to take a while, probably as long as two years.
That means we should be expecting some revenue blips in the meantime.
Meanwhile, parks and resorts keep on growing with a 6% revenue increase and 8% operating income increase. As Disneyland completes its makeover of Future Land or Space Land or whatever it was called, into StarWars Land, expect revenues there to improve even more.
What’s not to love about studio entertainment at DIS? Between Star Wars, a zillion Marvel films, Jungle Book, Finding Dory (Pixar!) and even Cinderella, there was a 40% revenue increase for the segment, leading to a 62% increase in operating income.
There’s only one downside to this segment, which is that it costs a ton of money to make a lot of money ($766 million operating profit). It’s hard to believe that even with all these amazing studio properties, but sports still dominate earnings.
Bottom Line on DIS Stock
Naturally, DIS stock continues to be a cash cow. It generated $5.7 billion in free cash flow so far this fiscal year and has $5.22 billion in the bank. That’s how it can fund everything it does.
So, on expected fiscal year net income of about $10 billion, which would be about a 10% increase from last year, Disney stock trades at about 15x. It isn’t the GARP stock it once was, but I do give it a premium because of free cash flow, cash on hand and its world-class brand. Thus, I think it’s probably fairly valued here at $95.
That means you could expect about 10% growth annually going forward, plus the 1.5% yield. However, I suspect the market could push Disney stock down as low as $85 over the next year. If you own Disney, hold it. If you don’t own it, you may want to either nibble here or buy in slowly on declines.
As of this writing, Lawrence Meyers was long DIS.