Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of Disney (NYSE:DIS), in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess Disney's financial condition. The information that I am using for this article comes from the company's website here. Note that this article is not a comprehensive review as to whether Disney should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it. More information on how I analyze financial statements can be found at my website here.
Disney is a diversified worldwide entertainment company. Its operations are divided into five segments. They are Media Networks, Parks and Resorts, Studio Entertainment, Consumer Products, and Interactive.
Their Media Networks segment has accounted for 46% of the company's revenue over the last nine months. The operations of this segment include international and domestic cable TV networks like ESPN, ABC Family, and Disney Channels worldwide. They are involved in domestic broadcast television, as they own the ABC Television Network, ABC Studios, and eight domestic TV stations. Their television production operations under the ABC Studios banner include shows like Castle, Criminal Minds, Private Practice, and Jimmy Kimmel Live, along with evening news programming. Also, their productions are distributed worldwide in pay and syndication markets. Of their eight domestic TV stations, six of them are in top-10 U.S. markets. Disney's Media Networks segment also owns a stake in Hulu, which allows customers to view programming on the internet.
Their Parks and Resorts segment contributed 31% of Disney's revenue over the last nine months. This segment owns and operates Walt Disney World Resort in Orlando, Florida. It also owns and operates Disneyland in California, a Disney Resort & Spa in Hawaii, and the Disney Cruise Line. The Parks and Resorts segment owns a 51% interest in Disneyland Paris, a 48% stake in Hong Kong Disneyland Resort, and a 43% interest in Shanghai Disney Resort.
Disney's Studio Entertainment segment was responsible for 13% of the company's revenue over the past nine months. This segment produces and acquires live-action and animated motion pictures, direct-to-video content, musical recordings, and live stage plays. They distribute acquired films in theaters, home entertainment, and TV markets under the banners of either Walt Disney Pictures, Pixar, or Marvel. This segment also owns 99% of UTV, which produces and distributes live-action and animated content in India.
The company's Consumer Products segment accounted for just under 8% of Disney's revenue over the last nine months. The operations of this segment involve licensing characters from its films and TV shows for use on third-party products, like toys, apparel, furniture, footwear, etc., from which the company earns royalties. Popular characters that can be seen on these third-party items include Mickey Mouse, characters from Cars, and Winnie The Pooh. The Consumer Products segment also creates, distributes, licenses, and publishes children's books, magazines, and digital products around the world. They also sell Disney and Marvel-themed products through retail stores and online.
And, lastly, the Interactive segment is comprised of two businesses. They are Interactive Games and Interactive Media. Together, these businesses accounted for 2% of the company's revenue. Interactive Games produces video games, handheld games, online games, as well as games that can be played on a smartphone. Interactive Media develops, produces, and distributes content through numerous websites that include Disney.com and the Disney Family Network. They also perform website maintenance and design for other businesses under the Disney umbrella.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
Disney is one such company. As of June 29, 2013, Disney had $3.93B in cash and cash equivalents, which can be easily converted into cash. Over the last 12 months, Disney repurchased approximately $3B worth of stock, and paid out $1.32B in dividends. The dividends and buybacks are well-supported by the company's trailing twelve-month free cash flow of $5.52B.
As of June 29, 2013, the company still had an authorization to buy back 183 million shares. This is great for shareholders as long as the buybacks are done at favorable prices, as it boosts earnings per share, and splits up the money allocated for dividends over fewer shares, which should result in enhanced dividend growth.
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
Disney had a total of $6.57B in net receivables on its balance sheet, which represents 14.8% of its trailing 12-month sales of $44.3B. For fiscal 2012, 15.5% of its sales were booked as receivables, while that percentage was at 15.1% for fiscal 2011.
While this figure is high in absolute terms, it has been fairly consistent, and is more than likely reflective of the nature of the company's businesses. I don't see anything to be alarmed about here.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of Disney is 1.26, which is very good.
Property, Plant and Equipment
Every company, regardless of the industry in which it operates, requires a certain amount of capital expenditure. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage.
However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors. Right now, Disney has $21.9B worth of property, plant, and equipment on its balance sheet. This figure is slightly above the $21.5B that the company reported at the end of fiscal 2012, and significantly more than the $19.7B that it reported at the end of fiscal 2011. Of these assets, 82% is tied up in attractions, buildings, and equipment. The increase in property, plant, and equipment during fiscal 2012 was due to the expansions of some of their resorts, and construction costs at Shanghai Disney Resort.
Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case-by-case basis, as good companies are rarely purchased at or below book value.
Disney has $27.3B worth of goodwill on its most recent balance sheet, which is higher than the $25.1B worth of goodwill that it reported 9 months prior. It is also higher than the $24.1B that was reported at the end of fiscal 2011. The increase in goodwill that we have seen over the past 9 months is due to the company's acquisition of Lucasfilm earlier this year for $4.1B, resulting in a $2.3B addition to goodwill.
Overall, goodwill accounts for about 34% of Disney's total assets. Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed at the beginning of this section. Since Disney is above this threshold, this may be an area of concern. While Disney hasn't had any significant write downs in goodwill over the last couple of years, if it does have any significant write downs going forward, then it can negatively impact the share price, due to the decline in the company's net worth.
Intangible assets that are listed on the balance sheet include items such as licensed technology, patents, brand names, copyrights, and trademarks that have been purchased from someone else. They are listed on the balance sheet at their fair market values. Internally developed intangible assets do not go on the balance sheet in order to keep companies from artificially inflating their net worth by slapping any old fantasy valuation onto their assets. Many intangible assets like patents have finite lives, over which their values are amortized. This amortization goes as annual subtractions from assets on the balance sheet and as charges to the income statement. If the company that you are researching has intangible assets, with finite lives, that represent a very large part of its total asset base, then you need to be aware that with time, those assets are going to go away, resulting in a reduction in net worth, which may result in a reduction in share price, unless those intangible assets are replaced with other assets.
Disney currently has $7.43B worth of intangible assets on its balance sheet. This is higher than the $5.02B that it had 9 months prior, as well as the $5.12B that the company reported at the end of fiscal 2011, and the $5.08B that was reported at the end of fiscal 2010. This increase is due to the Lucasfilm acquisition, where $2.6B of intangible assets were acquired. These assets have a useful life of 40 years, so the assets will be amortized very slowly. The same can be said for many of their other intangible assets.
While the eventual loss of $7.43B from the balance sheet is not a good thing, considering that amount accounts for only about 9% of the company's total assets, and the fact that a lot of this amortization will go on for at least the next four decades, I don't see anything to be alarmed about here, going forward.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
For Disney, the return on assets would be $6.01B in core earnings over the last 12 months, divided by $80.6B in total assets. This gives a return on assets for the trailing twelve months of 7.46%, which is decent. I also calculated Disney's returns on assets over fiscal years 2012, 2011 and 2010 for comparative purposes. This can be seen in the table below.
Table 1: Growing Returns On Assets At Disney
The numbers shown in the above table are decent returns on assets, and they show that management is doing a good job at making efficient use of what it has as its disposal. These returns have been slowly rising over the last 2-3 years.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
Disney has $2.22B worth of short-term debt, most of which is commercial paper obligations that carry an interest rate of close to zero. Given the company's cash position of almost $4B, their free cash flow of $5.5B, and the ability to refinance some of this debt at very low interest rates, this short-term debt is very manageable for Disney.
Long-term debt is debt that is due more than a year from now. An excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, Disney carries $12.8B of long-term debt. This figure is significantly above the $10.7B that was reported just 9 months prior, as well as the $10.9B that was reported at the end of fiscal 2011. The vast majority of this debt is in U.S. medium-term notes, with an average interest rate of 3.8%.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of the company's core earnings over the last 3 fiscal years. The average core earnings of Disney over this period is $4.82B. When you divide the long-term debt by the average earnings of the company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For Disney, here is how it looks: $12.8B / $4.82B = 2.66 years
This is pretty good for Disney, in that the company can pay off its long-term debt with less than three years' worth of earnings. If it wanted to, it could also dip a little bit into its cash position to pay some of it off. To me, this shows that the company's debt position, while seemingly large, is still manageable when considering the company's earnings power.
In the equity portion of the balance sheet, you will find the treasury stock. This figure represents the shares that the company in question has repurchased over the years, but has yet to cancel, giving the company the opportunity to re-issue them later on if the need arises. Even though treasury stock appears as a negative on the balance sheet, you generally want to see a lot of treasury stock, as strong, fundamentally-sound companies will often use their huge cash flows to buy back their stock. For this reason, I will often exclude treasury stock from my calculations of return on equity and the debt-to-equity ratio in the case of historically-strong companies, as the negative effect of the treasury stock on the equity will make the company in question appear to be mediocre, or even severely distressed, when doing the debt-to-equity calculation, when in reality, it might be a very strong company. In this case, I will try to calculate the debt-to-equity ratio and the return on equity both ways to help give the reader an idea as to how much effect the treasury stock really has.
Disney, which most can agree is a historically-strong company, has a whopping $33.2B in treasury stock.
The debt-to-equity ratio, as normally calculated, is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how Disney stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity
For Disney, the debt-to-equity ratio is calculated by dividing its total liabilities of $34.7B by its shareholder equity of $43.5B. This yields a debt-to-equity ratio of 0.80.
This tells us that Disney is in fairly decent shape with regard to its debt and equity positions.
However, when you cancel out the negative effects that the treasury stock has on the equity, it gets even better.
In these instances, I calculate what I like to call the adjusted debt-to-equity ratio. It is calculated as follows.
Adjusted Debt-To-Equity Ratio = Total Liabilities / (Shareholder Equity + Treasury Stock)
Using the data from the most recent balance sheet of Disney, this figure is calculated as: $34.7B / $76.7B = 0.45. The tables below show how both the normal and adjusted debt-to-equity ratios have changed over the last few years.
Table 2: Debt-To-Equity Ratios Of Disney
Table 3: Adjusted Debt-To-Equity Ratios Of Disney
From these two tables, we can see that Disney's debt is very manageable when compared to its equity position. Both ratios are well below 1.0, and have been very consistent. This is good to see, when assessing a company's financial condition.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholder Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. However, Disney is not one of these companies.
So, the return on equity for Disney is as follows:
$6.01B / $43.5B = 13.8%
This appears to be a pretty solid return on equity. In the table below, you can see how the return on equity has fared over the past three years.
Table 4: Returns On Equity At Disney
Adjusted Return On Equity = Net Income / (Shareholder Equity + Treasury Stock)
When I strip out the negative effects of the treasury stock, here is what I come up with when using the data from the most recent balance sheet.
Adjusted Return On Equity = $6.01B / $76.7B = 7.84%.
This appears to be a pretty solid return on equity, although it's not much to write home about either. In the table below, you can see how the adjusted return on equity has fared over the past three years.
Table 5: Adjusted Returns On Equity At Disney
While in the high single digits, Disney's adjusted returns on equity are very consistent and slightly rising.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Below, you can see how the retained earnings have fared at Disney at the ends of each of the last four fiscal years.
Table 6: Retained Earnings At Disney
From the above table, you can see that Disney has an impressive retained earnings figure of $43B, and that it has been steadily growing since the end of fiscal 2009, at a cumulative rate of 38.7%. This has been happening as the company has been buying back stock and paying dividends, although some such as yours truly wish the dividends were higher. These impressive figures are a testament to the strong earnings power of Disney.
After reviewing the most recent balance sheet, it can be concluded that there are a lot of things to like about the financial condition of Disney. For starters, Disney has a very good current ratio, which shows that the company has enough current assets on hand in order to meet its short-term obligations in the event that its operations encounter an unlikely disruption. Disney has solid and consistent returns on assets and equity. The company's debt is also quite manageable, as can be seen by its debt-to-equity ratio and the fact that less than three years worth of earnings could cover its long-term debt. Retained earnings growth has also been very good, leaving Disney with plenty of money to reinvest back into the company for more growth.
At this time, the only concern that I have with Disney's balance sheet is the fact that goodwill accounts for over a third of the company's total assets. While this hasn't been a problem yet, if some of the company's acquisitions don't produce the value that was originally expected by management, then some of that might come off of the balance sheet, reducing the company's net worth and potentially hurting the company's stock price.
While this is not a comprehensive review as to whether Disney should be bought or sold, I think that the company is in pretty decent financial shape overall, with its manageable debt, economic moats, brand strength, and tremendous earnings power. As long as it can keep generating consistent returns on assets and equity and maintaining its relatively low debt levels, I remain optimistic on its prospects.