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Summary

  • The intrinsic value estimate is $75 per share.
  • Recent financial performance is transient.
  • The primary degree bull market is "long-in-the-tooth."

The share price of the Walt Disney Company (NYSE:DIS) increased significantly following the release of fiscal first-quarter earnings. At this point, the valuation is rich. The underlying fundamentals of the company do not support the valuation going much higher.

While Disney is forecasted to continue to grow in the mid-single digits, the underlying return generating ability of the business does not support a higher valuation. As it stands, the valuation is above the historic average levels, and industry and market benchmarks.

Given the valuation, Disney is a short sale candidate with an intrinsic value estimate of $75 per share.

Recent Developments

  1. Frozen became the top-grossing animated film in box office history, topping $1 billion in global sales.
  2. Disney agreed to acquire Maker Studios, the leading network of online video content on YouTube.
  3. Ben Sherwood will become the co-chairman, Disney Media Networks and president, Disney/ABC Television Group on February 1, 2015. (Yes, 2015 is correct, and yes, that is quite awhile from now. Oh and no, I won't be replacing him running ABC News.)

Business Summary

Walt Disney Co., together with its subsidiaries, is a diversified entertainment company that has five operating segments: Media Networks, Parks and Resorts, Studio Entertainment, Consumer Products, and Interactive.

Disney has potentially sizable multi-platform upside from its large stable of popular entertainment brands franchises and characters, which is combined with a strong management team. On the downside, the core business is vulnerable to a slowdown in consumer discretionary spending and has relatively high exposure to the capital-intensive theme parks business.

In terms of the industry, consumer spending is expected to remain relatively weak, which adversely impacts the movies and entertainment sub-industry. But there is room from growth in newer distribution channels, such as online streaming, video on demand, and mobile devices. This comes as traditional formats, DVD and CD, are phased out. Additionally, industry consolidation should increase the profitability profile and drive returns to shareholders.

From the corporate governance perspective, Disney should have an independent chairman of the board, as currently, Robert Iger serves as both chairman of the board and chief executive officer. With Iger serving in dual roles, the company is able to control the board's agenda and the culture of the boardroom, which can be detrimental to shareholders. But it appears that Iger's compensation isn't excessive, as Leslie Moonves of CBS earned $62M in 2012, while Iger earned $40M. Also, Philippe P. Dauman earned $33.5M in 2012.

For the year ending (in millions of dollars, except per share data):

2011-09

2012-09

2013-09

2014-09E

2015-09E

Revenues

$40,893

$42,278

$45,041

$47,068

$49,186

Gross profit

$7,781

$8,863

$9,450

$9,884

$10,575

Operating income

$7,726

$8,763

$9,236

$9,649

$10,329

Disney's net income

$4,807

$5,682

$6,136

$6,472

$6,886

Diluted EPS

$2.52

$3.13

$3.38

$3.64

$3.95

Disney is viewed as a 4%-5% per annum growth rate company. For now, the first-quarter results are thought of as transient, and the expectation is that results for the rest of the year will be in line with the long-term growth rate. In terms of profitability, Disney is expected to post moderate improvements in the profitability margins on the impact of operating leverage. Consequently, diluted EPS is forecasted to increase 7.7% for the full year.

2011-09

2012-09

2013-09

2014-09E

2015-09E

Asset turnover

0.57

0.56

0.55

0.54

0.53

Ending financial leverage

1.93

1.88

1.79

1.83

1.85

Debt-to-capital

0.37

0.36

0.31

0.30

0.33

Total asset turnover is forecasted to continue trending lower as total assets grow faster than sales. Also, financial leverage and debt-to-capital are forecasted to increase as the company returns capital to shareholders and issues additional debt in 2015. Overall, the capital structure allows management to issue additional debt, should the need arise.

For the year ending (in millions of dollars):

2011-09

2012-09

2013-09

2014-09E

2015-09E

Cash provided by operations

$6,994

$7,966

$9,452

$10,826

$11,805

Capex

$3,559

$3,784

$2,796

$3,000

$3,300

FCFF

$3,718

$4,498

$6,897

$8,046

$8,743

FCFE

$5,082

$4,606

$7,035

$8,326

$9,505

Common stock repurchases

$4,993

$3,015

$4,087

$4,000

$5,000

Dividend payments

$756

$1,076

$1,324

$1,456

$1,602

Cash provided by operations is forecasted to grow faster than revenues as the working capital requirements decline. Also, the expectation is for continued strong free cash flow to the firm and free cash flow to equity growth. The dividend is anticipated to increase at 10% per annum.

Overall, Disney should have an excellent fiscal year as the global economy continues to expand. There may be a "let-down" from the box office relative to Frozen, but management seems to have at least a decent line-up planned for the summer of 2014. Disney is forecasted to earn more than its cost of capital; in addition to the share repurchase program, the ROIC should leave the share price with limited downside risk.

Risks

  1. The share price is likely to remain volatile, and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in DIS in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. Competition in product development and pricing could adversely impact performance.
  5. Incorrect forecasts of customer demand could adversely impact the results of operations.
  6. Higher interest rates may reduce demand for DIS's offerings, and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in DIS.

Portfolio & Valuation

(click to enlarge)

Disney is in an intermediate and primary degree bull market. From a cycle perspective, the rally looks a bit stretched. At the same time, the trend may continue until there is a bearish catalyst.

Monthly expected return

Quarterly expected return

Quarterly standard deviation of returns

2.32%

6.95%

12%

Intrinsic value estimates

Forward price multiples based on base case valuation

Optimistic

$96.06

P/E: 20.68

Base case

$75

P/S: 2.84

Pessimistic

$45.94

P/BV: 2.81

P/CFO: 12.36

At the current share price, the valuation is starting to get stretched. At the same time, the share price is not above the optimistic valuation; consequently, Disney isn't clearly overvalued. The forward price multiples, based on 2014 results and the base case intrinsic value, are above the historic average valuations. From that perspective, Disney is overvalued. In conclusion, the fundamentals of the firm are excellent, but the shares are overvalued.

Source: Disney: Solid Fundamentals Leave Shares Overvalued