Disney Paints A Cloudy Picture For 2013

| About: The Walt (DIS)

Media giant Disney (NYSE:DIS) reported solid fiscal year 2012 fourth quarter results Thursday, Nov. 8. The company saw revenue jump 3% year over year to $10.8 billion, a tad below consensus expectations. Earnings were in line with expectations, increasing 17% year over year to $0.68 per share. To find out Disney's intrinsic value, please click here.

Free cash flow, one of our favorite metrics when evaluating a company, was nearly cut in half during the period to $602 million, though the decline reflected accounting timing more than any broader weakness. Fiscal year 2012 free cash flow jumped 22% year over year to $4.2 billion -- enough to pay for the Lucasfilm deal on its own. Despite the hiccup in the current period, we expect free cash flow trends to remain strong at the media giant.

On a segment basis, media networks revenue growth was modest, up 2% year over year to $4.9 billion, though operating income grew 7% to $1.6 billion. ESPN advertising revenue was solid during the fourth quarter, but management noted on the conference call that rates were down in the first quarter. And while ESPN is boosting revenue nicely via affiliate fees, the battle for live content has been nudging up content costs, an event that could impair earnings growth -- particularly if marginal advertising dollars fail to increase. We also fear that networks, including ESPN, may be paying top-dollar for declining sports such as baseball and college basketball, though popularity trends could always shift.

Broadcasting revenues, which include ABC and related revenues, grew only 1% to $1.3 billion, with operating income falling 4% to $192 million. This pace of expansion is slightly surprising given the expected boost from the political season, but it really reflects the shift in media consumption currently under way. Netflix (NASDAQ:NFLX) has largely eliminated the need to purchase DVDs and Blu-Rays, and the way people consume TV shows continues to change due to Hulu, piracy, and DVRs. Absent a large consumer hit, management seems modestly excited about the broadcast segment's potential in 2013. However, we're bearish on the long-term fate of network television, which will have to undergo some significant structural changes to thrive, in our view.

The firm's parks and resorts segment continues to experience a renaissance, with revenues growing 9% year over year to $3.4 billion, and operating income surging 18% to $497 million. Strength was broad-based, with everything from Disneyland Paris to Disney Cruises performing better during the fourth quarter. Investment in park expansions was high during 2012, and management reiterated that investment expenditures will remain high in 2013. We like the firm's decision to invest now, especially with the echo-boomers entering childbearing age and ready to take vacations and spend money on their children. Great companies invest decades at a time, and we think Disney's recent strategy, including the acquisition of "Star Wars," reflects this strategy.

Studio entertainment performance was mediocre during the fourth quarter, as revenue fell 4% to $1.4 billion and operating income declined 32% to $80 million. The company blamed tough comparisons, with "Brave" lapping "Cars 2," and a huge marketing push for "Frankenweenie" prior to its fiscal-year 2013 release. The release slate looks decent in 2013, driven by "Iron Man 3" and "Monsters University." However, these films will be lapping "The Avengers," so we aren't incredibly optimistic about year-over-year expansion. However, 2015 might be the most incredible year in studio history -- "Star Wars Episode 7" and "The Avengers 2" should both be absolute blockbusters.

Overall, we thought the quarter was fairly strong, but CEO Bob Iger sounded somewhat tempered about 2013 expectations. Several important shifts in Disney's core businesses are under way, and advertising revenues on cable TV are facing modest headwinds while broadcast advertising revenues are facing a shift in the industry business model. Still, the company inked a landmark deal to gain ownership of "Star Wars," and it continues to possess several top-notch properties. Owning such a large amount of content puts Disney firmly in the driver's seat to command top dollar for its content. Shares of the firm trade at the high end of our fair value range, so we aren't interested in adding them to the portfolio of our Best Ideas Newsletter at this time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.