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Summary

  • In the latest installment of our Head-To-Head series, we pitch two companies from the entertainment sector, Disney and Time Warner, against one another.
  • The article focuses on the relative strengths and weaknesses of Disney and Time Warner based on business performance and sustainability/dividends.
  • It concludes by discussing the current valuations of the two companies, and answers whether Disney represents good relative value at current price levels.

Disney Background

Disney (NYSE:DIS) was founded in 1923 and is based in Burbank, California. The company operates in five segments: Media Networks, Parks and Resorts, Studio Entertainment, Consumer Products, and Interactive. The Media Networks segment operates broadcast and cable television networks, domestic television stations, and radio networks and stations. The Parks and Resorts segment owns and operates the Walt Disney World Resort in Florida that includes theme parks; hotels and vacation club properties. The Studio Entertainment segment produces and acquires live-action and animated motion pictures, direct-to-video content, musical recordings, and live stage plays. The Consumer Products segment licenses trade names, characters, and visual and literary properties to retailers, show promoters, and publishers. The Interactive segment creates and delivers entertainment and lifestyle content across interactive media platforms.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We score each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Sustainability/Dividends

  1. Debt to equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Forward yield
  5. 5 year average yield

Once we have scores for the two buckets, we can then assess whether a company represents good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price to earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. Price to sales ratio
  5. 5 year price to earnings growth ratio

So, for example, a company that scores well compared to its rival on the first two buckets (business performance and sustainability/dividends) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below highlights the data that we will use to score Disney and Time Warner (NYSE:TWX) for the first two buckets.

Stock

Disney

Time Warner

Business Performance

Return on equity

16.42%

13.63%

Return on assets

8.32%

6.62%

Operating margins

23.16%

23.56%

Quarterly rev. growth

10.40%

8.70%

Quarterly EPS growth

26.70%

71.40%

Sustainability/Dividends

Debt to equity ratio

32.75%

67.54%

Interest cover

Positive net interest

7.24

Dividend payout ratio

22.00%

26.00%

Forward dividend yield

1.00%

1.90%

5 year average yield

1.20%

2.30%

We then score each company relative to its peer based on the above data, with points being awarded as follows:

1st place: 10 points

2nd place: 0 points

Below are the scores for Disney and Time Warner:

Stock

Disney

Time Warner

Business Performance

Return on equity

10

0

Return on assets

10

0

Operating margins

0

10

Quarterly rev. growth

10

0

Quarterly EPS growth

0

10

Sustainability/Dividends

Debt to equity ratio

10

0

Interest cover

10

0

Dividend payout ratio

10

0

Dividend yield

0

10

5 year average yield

0

10

Total Score

60

40

As you can see, Disney is the clear winner of the two stocks. It outscores Time Warner by 60 points to 40, with Disney impressing us in terms of its profitability in particular. For example, it has managed to deliver return on equity of 16.42% and return on assets of 8.32%, which are both highly impressive numbers when you consider that Disney runs a very low-risk balance sheet. Furthermore, despite it losing out to Time Warner in terms of operating margins, the difference is very small and we feel Disney's margins are very strong. In addition, double-digit quarterly revenue and earnings growth is great news for investors and shows that Disney is delivering on its growth potential.

As well as scoring well on business performance, Disney is also a highly sustainable business. It carries very low debt on its balance sheet, with a debt to equity ratio of just 32.75%, while it received more interest than it paid out last quarter, which bodes well for its sustainability. Despite not yielding as much as Time Warner, Disney's low comparative payout ratio of just 22% means that there is plenty of scope for dividend increases going forward.

Valuation

So, we feel that Disney has performed very strongly in the first two buckets and, as such, should trade at a substantial premium to its sector peer, Time Warner. Let's see if it does.

Stock

Disney

Time Warner

Valuation

Forward price to earnings ratio

18.83

15.74

Price to book ratio

3.30

2.14

EV/EBITDA

12.34

10.01

PEG

1.29

1.34

Price to sales ratio

3.21

2.10

Disney trades at a premium to Time Warner on four of the five valuation criteria, with the PEG ratio being the only metric on which it is cheaper than its peer at current prices. However, the premium is not as great as we would expect, since Disney easily outperformed its peer in the first two buckets, so an EV/EBITDA ratio of 12.34 for Disney versus 10.01 for Time Warner is, for instance, a little narrower than we would have anticipated. Similarly, a forward P/E of 18.83 for Disney versus 15.74 for Time Warner does not, in our view, fully reflect the difference in quality identified by the first two buckets. Therefore, as the lower PEG shows (1.29 for Disney versus 1.34 for Time Warner), there could be scope for Disney to outperform Time Warner going forward.

Conclusion

Disney is a great company that we believe offers good value at current levels. It scored highly on the Team Money Research rating system, beating its sector peer, Time Warner, by a wide margin. It also appears to be relatively undervalued at current levels since the premium on which it trades to Time Warner seems to be rather tight and, as such, we feel it could outperform its sector peer going forward.

Feedback Request: What do you think about Disney? Would you buy, sell or hold right now? Please comment below!

Source: Head-To-Head: Can Disney Survive?