Disney (DIS) thoroughly trounced expectations in its second-quarter earnings release. But before you buy Disney stock, take a look at what’s driving revenues. Bulls aren’t likely to see a fairytale ending.
Disney announced earnings after the market close on Tuesday. Adjusted earnings per share came in at $1.11, up from 79 cents in the prior-year quarter and 15 cents ahead of the 96 cents consensus estimate. Revenues for the quarter were $11.6 billion, up 10% from the prior year.
On the surface, those number are fantastic. But picking apart the revenue numbers, the story gets a lot more interesting. A disproportionate share of the revenue growth came from two of Disney’s smaller — and most volatile — divisions, Studio Entertainment and Consumer Products. Company-wide, revenues rose $1.1 billion in the quarter; $462 million of that growth came from movies and $122 million from Consumer Products — essentially the merchandising from said movies.
|Parks and Resorts||3,562||3,302||8%|
So, what’s the problem?
The problem is that these figures are not sustainable for Disney stock. They were massively juiced by ticket sales of Frozen, which has leapt ahead of Toy Story 3 to become the highest-grossing animated movie in history. Thor: The Dark World, one of the recent additions to the Marvel cinematic universe, was also a significant success. (Animated movies are vastly more profitable than live-action movies, by the way. See “Investing in Oz.”)
Nothing against these movies, of course. My kids loved Frozen (my four-year-old son called it Princess Iceman), and my inner geek loved Thor. But winners like that don’t come along every year. And meanwhile, Disney’s TV revenues only rose by 4% and its Parks and Resorts revenues rose by only 8%.
Investors new to Disney stock often think of Disney as a movie studio. But it is first and foremost a TV studio, as the owner of the ABC network, the ESPN networks, and the Disney Channels, among others. TV revenues, at $5.1 billion for the quarter, made up 44% of total revenues. A year ago, it was 47%.
And herein lies a problem.
Television is an industry undergoing a transformation, and no one is exactly sure how the revenue model will shift in the coming years. Disney stock reported lower advertising revenues in both its cable and broadcast channels. These were offset by “contractual rate increases to affiliates.” In other words, your cable company paid Disney more for the rights to the ESPN and Disney channels.
That’s good, right?
In a vacuum, yes. But the cost of monthly cable bills have been increasing at a rate of about 6% annually. The average cable bill was $86 in 2011. By 2015, it is forecast to be $123 per month. Given that income growth has been stagnant for years, that’s not a sustainable trend. Ironically, Disney’s ESPN is the number-one culprit; the ESPN channels are alone responsible for about $5.50 per month.
If cable packages were unbundled, allowing customers to pick and choose which channels to buy a la carte, or if the trend towards “cord cutting,” or cancelling paid TV altogether, accelerates, it’s unclear what effect this would have on Disney stock. For many American homes, televised sports are the reason they’re willing to pay for cable. In a world of unbundled pricing or a standalone streaming service, ESPN might actually pull in more viewers than ever.
Maybe, maybe not. I think a more likely outcome is that a combination of rising consumer dissatisfaction and political pressure will keep a lid on cable bills going forward, which will in turn put pressure on the content providers like Disney.
What about Disney’s theme parks, which made up 31% of revenues this past quarter? Here, Disney stock should benefit from a demographic dividend — for a few short years.
American births hit an all-time high in 2007 before collapsing during the financial crisis. Those babies born in 2007 are now seven years old and just entering their prime years for visiting Disney World. These demographic trends should provide a nice tailwind for the next few years. But by the end of this decade, Disney should start to feel the effects of the baby bust.
So, what does any of this mean for Disney stock? I love Disney’s branding power and its diverse array of businesses. But I’m not willing to pay a large premium for a company whose primary revenue source — paid television — looks threatened. Disney trades for 22 times trailing earnings and 17 times expected 2015 earnings. And its dividend yield — at 1.1% — is downright stingy. At these prices, Disney stock is a sell.
This article first appeared on InvestorPlace.
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