- Disney has a market cap of $144 billion and is responsible for $9.5 billion in pension assets (at FYE 9/28/13).
- Half of the pension costs are tied to the Parks and Resorts business.
- When competing for customers and employees, Disney has a competitive disadvantage. More recently formed media companies do not have a pension albatross around their neck.
The Walt Disney Company (NYSE:DIS) is an old enterprise. The company had its IPO in 1940, when it was known as Walt Disney Productions.
The scope of this article is the risk posed by Disney's pension obligation, and DIS is at a competitive disadvantage in being able to focus on core operations. DIS shareholders desire that management focus on ad rates at ESPN and efficiently providing strong customer service at the theme parks. Shareholders do not want to concern themselves with discount rates or the portfolio asset allocation in a $9.7 billion pension portfolio (at 9/28/13, the most recent publicly available figure).
Facebook and Disney are not direct competitors, except in the general sense that both compete for eyeballs. For example, a user of media might watch SportsCenter in the morning (a Disney product), or may look at his Facebook posts. The management of both companies should focus attention to servicing those consumers. Disney management has numerous growth initiatives including the MyMagic+ product at the parks and the Shanghai Disney construction. Disney management should not be navigating the pension landscape.
Disney's Pension and Postretirement Medical Costs
Pension and postretirement medical benefit plan costs affect results in all of Disney's segments, with approximately one-half of these costs being borne by the Parks and Resorts segment.
The Company recognized pension and postretirement medical benefit plan expenses of $698 million, $626 million and $576 million for fiscal years 2013, 2012 and 2011, respectively. The increase in fiscal 2013 was driven by a decrease in the assumed discount rate used to measure the present value of plan obligations. The assumed discount rate reflects market rates for high-quality corporate bonds currently available and was determined by considering the average of yield curves constructed from a large population of high quality corporate bonds. The resulting discount rate reflects the matching of plan liability cash flows (cash paid to the pensioners) to the yield curves (income from investments).
How does Disney's Pension Plan Affect the Balance Sheet?
(Billions of Dollars)
Postretirement Medical Plans
Pension benefit ending obligation
Ending fair value of plan assets
Underfunded status of the plan
During FY 13, DIS increased the discount rate to 5.00% at the end of fiscal 2013 from 3.85% at the end of fiscal 2012 to reflect market interest rate conditions at the September 28, 2013 measurement date. This increase in the discount rate will affect net periodic pension and postretirement medical expense (benefit expense) in fiscal 2014. Incredibly, this change in the discount rate played a large role in reducing the "Underfunded status of the plan" from $4.9 billion to $1.9 billion.
The Key Assumptions of the Pension plan are:
|Pension Plans||Postretirement Medical Plans|
|Rate of return on plan assets||7.50%||7.75%||7.75%||7.50%||7.75%||7.75%|
Discount Rate - The assumed discount rate for pension and postretirement medical plans reflects the market rates for high-quality corporate bonds currently available. The Company's discount rate was determined by considering the average of pension yield curves constructed of a large population of high quality corporate bonds. The resulting discount rate reflects the matching of plan liability cash flows to the yield curves.
Long-term rate of return on plan assets - The long-term rate of return on plan assets represents an estimate of long-term returns on an investment portfolio consisting of a mixture of equities, fixed income and alternative investments. The following long-term rates of return by asset class were considered in setting the long-term rate of return on plan assets assumption:
|Equities||9% to 12%|
|Debt securities||4% to 7%|
|Alternative investments||6% to 13%|
How Does Disney's Pension Plan Affect the Income Statement?
Millions of Dollars
Other comprehensive income (loss), net of tax
Pension and post retirement medical plan adjustments
Note that changes in the value of the pension plan, and changes in assumptions, do not affect the reported net income. These changes do affect the "Other Comprehensive Income (Loss)" on the income statement.
The Annual Report for DIS goes further to explain that if future investment returns do not exceed the 7.5% long-term expected returns and/or discount rates do not increase, a significant portion of the unrecognized pension and postretirement medical costs will be recognized as a net actuarial loss in the income statement over approximately the next 9 years.
How are the Assets Invested?
Plan Assets at 9/28/13
|Equities:||Dollars in millions||Percentage|
|Domestic small cap||$220||2|
|Domestic mid/large cap||1,864||19|
|Government and federal agency bonds, notes and MBS||1,572||17|
|MBS & asset-backed securities||322||3|
|Private equity/venture capital||673||7|
|Derivatives and other, net||119||1|
|Cash & money market funds||928||10|
Large cap domestic equities include 2.9 million shares of Disney common stock valued at $185 million (2% of total plan assets) at September 28, 2013.
Employees generally hired after January 1, 1994 are not eligible for postretirement medical benefits. Pension benefits are generally based on years of service and/or compensation.
I conclude that Disney is at a disadvantage given that management must focus their time on pension acrobatics. If Disney were to trade in line with the S&P 500 index, its current P/E could fall from roughly 21x to about 18x. Also, note that DIS has a below market dividend yield of 1% compared to an S&P 500 dividend yield of 1.7%.
This article does not describe the current drivers of the Disney business, which are critical to valuing the stock. These issues include attendance at the Parks, the commercial success of the Marvel business, and the performance of the ESPN business. Lastly, I am a Financial Analyst, and not an actuary. The above article is an opinion, and not investment counsel.