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Market Update

Hard to Find Flaws in Disney's 3Q Results

Disney's wide-moat business shined in the third-quarter, but shares look fairly valued, says Morningstar's Michael Corty.


Just a year ago, the market soured on  Walt Disney (DIS) for a hiccup in earnings and some perceived profitability weakness at the park business. We maintained our long-term outlook and the shares became a bargain, trading down to the low $30s. What a difference a year makes, as the company is firing on all cylinders, the market is excited about its prospects, and the stock is near our $50 fair value estimate. Both the cable networks and branded businesses are demonstrating their pricing power. However, one earnings hiccup or macroeconomic head-fake could give patient investors a better buying opportunity for this wide-moat company.

Overall revenue and operating income were up 4% and 18%, respectively. A large portion of the operating income growth was from the movie studio (which is inherently lumpy) due to the success of The Avengers, which swung segment operating income to $313 million from $49 million in the year-ago quarter. The reported cable networks growth of 2.7% appears weak on the surface, but excluding $139 million of affiliate fee deferrals, which are simply a timing issue, cable network sales growth was 7% and management indicated that affiliate fee growth is still in the high single digits. This reflects some recent rate increases for the ESPN networks as well as the often overlooked Disney Channel, which is having great audience rating success in the United States as well as higher pay-TV penetration overseas.

While the Olympics are doing well and have eaten into advertising across the television industry this summer, that window closes at the end of this week. ESPN has a tight grip on live sports, as we've highlighted repeatedly. On a trailing-12-month basis, cable network operating margins of 41.2% nearly matched their recent high. We view the increase in sports rights fees, especially for the NFL and college football, as manageable and believe the cable networks can maintain margins in excess of 40% over the next five years.

The park and resort business continued to generate impressive growth, especially in the U.S., with sales up 8.5% (10.2% domestic and 2.2% international). Attendance at domestic parks increased 1% with 7% higher per capita spending as Disney continues to gradually flex its pricing power. We think park attendance should pick up in the near term thanks to the improved California Adventure, which was opened in June.

The recent success of The Avengers validates our thesis that Disney's brands are as strong as ever. A sequel is in the works and also already slated for several of the hit characters who appeared in the movie. Relative to the higher-margin cable network business, the branded half of Disney is more capital intensive and requires acquisitions like Marvel. However, we view the wide moat on the Disney brand lasting for well over two decades into the future.

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Michael Corty does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.