Is Now An Excellent Time To Buy DreamWorks?

| About: Dreamworks Animation (DWA)

Summary

DreamWorks had a terrible quarter, with revenue and earnings getting hammered.

Disney, for all its success, hasn't seen amazing results either in recent years.

The big picture isn't earnings or revenue but is, instead, about developing a significant source of content that can be tapped into for years to come.

During trading on Jul. 30, shares of DreamWorks Animation SKG (NASDAQ:DWA) plummeted nearly 12%, hitting a new 52-week low along the way. On top of being hit by poor revenue and earnings results, management announced in its conference call that the Securities and Exchange Commission is looking into how the entertainment company wrote down its Turbo inventory during the prior quarter. Given these considerations, should investors opt for another entertainment business like The Walt Disney Company (NYSE:DIS) instead of DreamWorks, or will the company see a rebound from its troubles thanks, in part, to the success of How to Train Your Dragon 2?

DreamWorks falls short of the mark… significantly!

For the quarter, DreamWorks reported revenue of $122.3 million. In addition to missing the $137.9 million analysts forecasted, the company's top line came in 43% below the $213.4 million management reported the same quarter a year earlier. According to its press release, this decline in revenue was driven by a variety of factors at play, but the biggest contributor was a difference in the timing of revenue recognition.

Because of when How to Train Your Dragon 2 was released, the company booked revenue of just $2.6 billion from the film during the quarter, despite the movie earning $428 million in the box office thus far. This stands in contrast to The Croods, which, during the second quarter of 2013, had brought the studio revenue of $71.8 million on a box office release of $583.9 million.

Earnings Update
  Last Year's Forecasted Actual
Revenue $213.4 million $137.9 million $122.3 million
Earnings per Share $0.26 -$0.02 -$0.18
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From an earnings standpoint, DreamWorks' miss was even worse. For the quarter, management reported earnings per share of -$0.18. This is significantly lower than the $0.26 gain reported in last year's quarter and came in far lower than the -$0.02 investors wanted to see. This drop was brought about, in part, by the firm's lower revenue, but can also be chalked up to its cost of goods sold rising from 62.4% of sales last year to 71.6% and its selling, general and administrative expenses soaring from 23.3% of sales to 44.6%.

Is Disney a better long-term play?

When it comes to theatrical releases, it's difficult to compete against Disney. In 2013, the company's Studio Entertainment segment reported revenue of $5.98 billion and operating income of $661 million. To put this in perspective, Disney's operating income was nearly as large as DreamWorks' $706.9 million in sales during the year and was nearly 9 times larger than its operating income of $76.3 million.

In spite of this size difference, however, not everything is picture perfect at Disney's Studio Entertainment segment. Over the past three years, revenue has declined by 6% from the $6.35 billion management reported in 2011 to where it is today, but its operating income has grown by 7% from $618 million to $661 million. Although the top line may be somewhat worrying, none of this factors in Frozen, which has broken the box office with ticket sales totaling $1.27 billion.

(Revenue) 2013 2012 2011
DreamWorks $706.9 million $749.8 million $706 million
Disney's Studio Ent. $5.98 billion $5.83 billion $6.35 billion
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This alone has already proven to be a boon for Disney, as demonstrated by its higher Studio Entertainment revenue year-to-date. According to the company's most recent quarterly report, the segment's revenue has shot up 28% to $3.69 billion from the $2.88 billion reported the same six months last year. Operating income has been even more impressive during this timeframe, soaring 151% from $352 million to $884 million.

Over the same three-year period, DreamWorks hasn't done so bad itself. Unlike Disney, whose sales dropped, the company saw its revenue remain virtually unchanged, inching up from $706 million to $706.9 million. Led by higher selling, general and administrative expenses, on the other hand, DreamWorks' operating income has declined by 31% from $109.9 million to $76.3 million, making Disney the clear winner when it comes to profit growth.

(Segment Op. Income) 2013 2012 2011
DreamWorks $76.3 million -$65 million $109.9 million
Disney's Studio Ent. $661 million $722 million $618 million
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It should not be forgotten, however, that DreamWorks has a lot of upside potential moving forward. Now that How to Train Your Dragon 2 has started rolling (after a less-than-ideal box office debut), the business now has both that franchise and the possibility of a sequel to The Croods that it could always tap into. While it's unlikely that either of these assets can put on the same kind of show that its Shrek franchise has, they are, collectively, very big names that could garner a nice return for the company's shareholders down the road.

Takeaway

Right now, Mr. Market is anything but happy with DreamWorks. Because of the company's lackluster sales and poor earnings, it makes sense why, but the more important thing to consider is the big picture (pun very much intended). Throughout history, the feature film business has been very volatile, even to a giant as strong as Disney. However, with big brands developing more and more under its belt, DreamWorks looks like it has the potential to keep pressing forward.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in DWA over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.