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Summary

  • Disney reported earnings last night, posting terrific results.
  • Growth expectations for the medium term are too high and multiple contraction is possible.
  • Disney's dividend is too small for income investors and with growth expectations so high, shares look very expensive.

Disney (NYSE:DIS) reported earnings last night and the results were quite favorable. The company beat on the top and bottom lines and shares reacted in kind by moving up moderately in the after-hours session before flattening out to near where they closed yesterday. Shares have moved up immensely in the past three years and investors in Disney are left to wonder if there is any more room to run or if the rally is coming near a close. In this article, I'll attempt to assign a fair value to Disney shares in order to assess their value.

To do this I'll use a DCF-type model you can read more about here. Basically, the model takes inputs such as earnings estimates, which I've sourced from Yahoo!, dividend estimates, which I've set at 8% annual payout growth, and a discount rate, which I've set at 9%. For the discount rate I use the 10 Year Treasury rate and add a risk premium; for Disney I chose a risk premium of 6.5%. It's important to understand all of these inputs are subject to interpretation by individual users so your model may not look like mine.

 

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

       

Prior Year earnings per share

 

$3.39

$4.19

$4.63

$5.38

$6.25

$7.26

x(1+Forecasted earnings growth)

 

23.60%

10.50%

16.15%

16.15%

16.15%

16.15%

=Forecasted earnings per share

 

$4.19

$4.63

$5.38

$6.25

$7.26

$8.43

        

Equity Book Value Forecasts

       

Equity book value at beginning of year

 

$26.41

$29.74

$33.44

$37.82

$42.98

$49.06

Earnings per share

 

$4.19

$4.63

$5.38

$6.25

$7.26

$8.43

-Dividends per share

 

$0.86

$0.93

$1.00

$1.08

$1.17

$1.26

=Equity book value at EOY

$26.41

$29.74

$33.44

$37.82

$42.98

$49.06

$56.23

        

Abnormal earnings

       

Equity book value at begin of year

 

$26.41

$29.74

$33.44

$37.82

$42.98

$49.06

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

 

$2.38

$2.68

$3.01

$3.40

$3.87

$4.42

        

Forecasted EPS

 

$4.19

$4.63

$5.38

$6.25

$7.26

$8.43

-Normal earnings

 

$2.38

$2.68

$3.01

$3.40

$3.87

$4.42

=Abnormal earnings

 

$1.81

$1.95

$2.37

$2.84

$3.39

$4.01

        

Valuation

       

Future abnormal earnings

 

$1.81

$1.95

$2.37

$2.84

$3.39

$4.01

x discount factor(0.09)

 

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

 

$1.66

$1.64

$1.83

$2.01

$2.20

$2.39

        

Abnormal earnings in year +6

      

$4.01

Assumed long-term growth rate

      

3.00%

Value of terminal year

      

$66.85

        

Estimated share price

       

Sum of discounted AE over horizon

 

$9.35

     

+PV of terminal year AE

 

$39.86

     

=PV of all AE

 

$49.21

     

+Current equity book value

 

$26.41

     

=Estimated current share price

 

$75.62

     

As we can see the model produces a fair value of $75.62. It is important to understand that the model is not producing a target price; rather it is suggesting the price at which shares are a good value right now. My model is suggesting that Disney shares are only a good buy today, given the inputs I described above, at a price of $75.62 or below. Given that we are trading substantially higher than that right now, the model would suggest that shares are overvalued. I happen to agree with that assessment so we'll take a quick look at why I think this now.

Starting with the chart, DIS shares have gone up basically in a straight line for the past three years. As you can see shares have only touched the 200 DMA once after the rally pushed shares through it at the end of 2011 and promptly bounced right off of it and resumed their uptrend. We also see the 50 DMA is solidly above the 200 DMA for the duration of the rally and right now, sits $9 above it.

(click to enlarge)

In other words, the chart of DIS is beautiful. However, I do think there is some caution that is warranted. Shares are getting overextended above the 200 DMA in my view and are due to revert back to it. Given that shares have moved up so smoothly and haven't tested the 200 DMA for at least a year, I think shares may be getting overextended.

Disney's business is as strong as ever, with each segment posting revenue gains during the quarter. Media's revenue growth was slow but all other segments posted very respectable gains in the quarter, leading Disney to beat its revenue forecast handily. Disney has world class properties in all of its segments including its theme parks, ESPN, and arguably the premier movie studio in the world. All of those businesses are booming and thus, I don't have anything to point to in terms of Disney's business that would make me want to avoid shares.

However, there are other reasons I'd avoid shares and am even considering a short position in Disney. I mentioned the valuation of shares in the discussion of the model above and I do think Disney shares are quite expensive right now. Not only do I find their fair value to be in the mid-$70s but at 19 times forward earnings, Disney shares are in nosebleed territory for me. This is not a growth company; it is $150 billion entertainment juggernaut that, while dominant, has seen its shares nearly triple in a relatively short period of time. I just don't see the case for 19 times forward earnings in Disney's growth potential.

In addition, my model shows earnings forecasts from analysts and considering I'm showing Disney as overvalued based on those expectations, it's instructive to understand what we're looking at. Analysts are projecting 15%+ growth for the foreseeable future; that is an enormous amount of profit growth for such a huge company and those targets are robust indeed. I call this out because if Disney is overvalued based upon 15% earnings growth, imagine the growth it needs to achieve in order for its fair value to come back in line with its current price. I think earnings estimates are too high for Disney going forward and that will lead to some disappointments and a revaluation of the earnings multiple Disney is assigned.

Finally, Disney's dividend of 86 cents per share, good for around a 1% yield, is not a reason to buy the stock. Some mammoth companies, that are admittedly growing less quickly than Disney, at least offer large payouts of 3% or more to own the stock. With Disney, the yield is far less than the market yield and given how expensive shares are, I don't see a lot here for value or dividend investors.

Disney shares have had a very impressive run over the past three years and shareholders have done extremely well. However, I think that shares are overextended above the 200 DMA and due for a reversion to the 200 DMA, if nothing else for a test of it. I also think shares are too expensive on an earnings basis and the company's dividend is not enough for me to want to own shares. In short, the company is too expensive for value investors but isn't growing quickly enough for growth investors, while the dividend is too small for income investors. Disney is a great company but you can't pay any price just because a company is great; I suggest avoiding Disney shares and I will be looking to go short if shares pop a little off of the earnings announcement.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a short position in DIS 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.

Source: Are You Buying Disney After Earnings?