After Earnings: Disney The King Of Content

Nov. 7.13 | About: The Walt (DIS)

The Walt Disney Company (NYSE:DIS) reported earnings after the bell that failed to impress investors after a 35% rally in 2013. While the company beat with $0.77 on $11.6 billion in sales compared to estimates of $0.75 and $11.4 billion, it appears that investors are selling on the news a little bit to take some profits as the quarter was pretty sound and affirms the positive trajectory the company has going forward. Investors can access the quarterly release here.

For the quarter, revenue was up 7% annually while EPS gained 13%. Operating cash flows grew by 78% to $2.7 billion while free cash flow increased by more than 100% to $1.75 billion. For the year, free cash flow grew 59% to $6.656 billion, which will allow the company to continue returning capital to shareholders in 2014.

The one weak point in the quarter was in the company's Media Networks unit where revenue increased by 1% but operating income dropped by 8%. Breaking down this segment further, cable networks (led by ESPN) saw profits fall by 7% while broadcasting networks (ABC) fell by 18%. The primary driver behind these low numbers was increased content costs. ESPN had rate hikes with the NFL and MLB and added college football rights, which should boost revenue going forward. ESPN has become a leading cash driver for DIS, and it is important to note that Fox (NASDAQ:FOXA), CBS (CBS) and NBC (NASDAQ:CMCSA) have launched sports channels to compete with ESPN. With added bidders, content costs will likely continue to climb in coming years, though I believe it will be difficult to strip ESPN of its dominance. Moreover, advertisers covet sports programming because they are rarely watched on DVR, which has buoyed ad pricing. I expect continued strength from ESPN in 2014 and beyond, but investors should pay attention to the increased level of competition. I doubt ESPN can grow as fast in the next five years as it has the past five, but I believe 5% annual growth is a reasonable target.

ABC suffered from lower syndication sales and increased programming costs as the channel has shifted some of its prime time hours from reality television to scripted shows. Its new show, Agents of SHEILD, has brought in strong ratings and has helped to expand the Marvel Universe to television. ABC will also benefit in coming years from increasing retransmission fees. With reinvigorated programming, I am hopeful ABC numbers are stabilizing, though it will likely to continue underperforming Disney's other units.

It is also worth noting that Disney grew studio revenue by 7% and operating income by $28 million in the quarter despite the disastrous roll-out of The Lone Ranger. This is the third straight year Disney has lost more than $100 million on a film, and if the studio can make these major flops less frequent, income could grow dramatically. The studio is positioned for a fantastic quarter with Thor 2 likely to earn $210+ million domestically and over $600 million worldwide while Frozen should surpass $400 million worldwide and Saving Mr. Banks could near $150 million domestically.

Looking out over the next three years, no studio on the planet is as well-positioned as Disney. The company continues to build on its Marvel Universe after the massive success of The Avengers with a second Captain America and first Guardians of the Galaxy in 2014, but Disney's big year will be 2015. A second Avengers will be released that summer while Star Wars: Episode VII will be released that Christmas. Adding Star Wars to its roster will give Disney the ability to roll out 2 franchise films a year through the decade adding significant stability to studio earnings. Moreover, its Pixar unit delivers the most consistently profitable films in the industry and functions as the most powerful animated franchise around. There is no reason to expect anything but strong returns from this unit. Disney plans 2 Pixar films in 2014, unprecedented production from the animation house. We are also seeing a renaissance at Disney's namesake animation studio, which has released several profitable films in a row. Disney's studio is without a doubt the envy of the industry.

The studio will also provide a tremendous halo effect throughout the entire company by boosting its consumer products division as its franchises are built to sell tons of toys and merchandise. These characters also will keep customers flocking to its theme parks to interact with their favorite characters in the world. It is no coincidence that both of these units reported continued growth in the quarter and I expect continued growth in the high single-digits in 2014.

Simply put with ESPN, Marvel, Pixar, and now Lucasfilm, Disney has the brands that consumers want, which will continue to boost earnings through 2015. I expect 2014 to provide very similar growth to 2013 with revenue jumping by another 7% to $48 billion. I expect net income growth to be a bit faster, especially because there should be no film like The Lone Ranger that knocks $0.10 off earnings. Normalizing for this one-time item, I expect net income growth of about 10% and a 4-5% decline in the share count from Disney's buyback authorization, resulting in EPS of $3.95-$4.00. This gives Disney a forward multiple of 16.5x.

With the strength of its brands, strong execution, and low-teen EPS growth, I believe that this is an attractive multiple to purchase Disney shares, especially as 2015 will be a much bigger year than 2014 on an historically unmatched film slate. We are just beginning to see the fruitions of Disney's branded tent pole strategy, which will keep the company growing for several years on the back of consistent film production. Disney is my favorite name in the media space. Below $65, it definitely makes sense.

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.