Can DreamWorks Animation Rise Above the Market Turbulence?

Here is an interesting stock to highlight - DreamWorks Animation (DWA), probably one of the biggest competitors to Steve Job's Pixar Animation. Of course, the performance of companies like DreamWorks is highly related to how well their computer-generated movies released do during the year. DreamWorks had a few good ones in the past, such as Shark Tale, Shrek and Madagascar. So for 2007, how do you reckon they will do? Not bad, at the very least. We already know that in 2007 the third Shrek, Kung Fu Pandas and Bee Movie should give some support to their share prices.

Investors must understand that the computer-generated animators industry is very capital intensive, requiring huge amount of dollars invested in new technology, which is already on top of upgrading existing ones. Add to this the rapid demographic changes and preferences that make these investments highly risky, and if not done well, we could quite possibly see them filing for Chapter 11. Of course, DreamWorks in particular has been able to look beyond this, and by forming strong and strategic business partners with Hewlett-Packard (HPQ) and AMD (AMD), they can leverage the technological developments while it is still early.

But, in general, the entertainment industry (under whom these animation companies fall) has been impressive throughout 2006, in all aspects from average operating margins, lower expenses and net income across the board. Throughout the industry, almost like any others, a lot of combinations and deals, as well as spin-offs (look at Disney (DIS) ridding of their ABC Radio). Motion picture companies also crack down harder on piracy, and even companies like Warner Bros., Universal, Sony (SNE) and Paramount are holding hands to give out services like video-on-demand and other freebies to battle against BT and other Kazaa-like disasters. The end beneficiaries will be DreamWorks amongst others.

Their long-term growth outlook is also very favorable, with the improving technology, continued explosion of high-speed internet, digital broadcasting technology, and private equity investments which will continue to keep their eyes open for opportunities; this is in addition to the fact that continued consolidations amongst big players will loosen the stiff competition.

One thing I like about DreamWorks is how they actively seek supplements to their existing revenue steams. For example, their Flushed Away movie, released with Hugh Jackman, was combined with a launch of an online game in collaboration with AOL (TWX). Elsewhere, they work with McDonald's (MCD) and Kellogg's (K) to promote films through print, gift and toys and marketing campaigns on television and other media forms. Their recent 4th quarter performance was also, as I love to quote "better than expected". Their revenues were ahead of what analysts had been expecting, but because of a one-time $109 million charge from their Flushed Away production, their EPS ended up negative. Revenues were up 18% to $204.3 million from $173 million, driven by strong DVD sales of Over the Hedge and Madagascar, and domestic broadcast royalty revenues from "Shrek 2." Analysts were only expecting $160 million. For 2006, not-so-great releases were out, which mostly explained why everyone expected lower performance, and yet they were still able to surprise most. For 2007, I'd expect great boosters from both Shrek 3 and Bee Movie (with Jerry Seinfeld), simply because they've done so well before; hopefully these releases will be their cash cow.

Of course, I don't wish to be biased, even though I have a good view on DreamWorks. If we look at their past fundamentals, they aren't exactly very attractive, but I should still disclose a few for everyone's knowledge:

Price-to-Sales Ratio: Because DreamWorks' earnings are in and out of negative territories, P/S should be a better indicator. Sadly, they have a must higher P/S of 8.01 over the industry's average of 2.70.

Operating ROE: Tells us how much DreamWorks' earnings over shareholder equity relative to the industry. Again, sadly it's a lot less at 8.8% over industry's average of 19%.

Debt-to-Assets Ratio: Like I said, being in an extremely capital intensive industry, most of these companies rely heavily on debt. DreamWorks' has been doing better on this side with a ratio of of 870% over industry's norm of 2658%.

Take a closer look at their financials.

More recently, DreamWorks' board of directors also authorized a $150 million share repurchase program to be executed over the next 18 months, which should put some wings on their share prices as well. It always does.

I'm looking forward to their share price movement and their movies too of course. However, as the market seems to be dropping so much recently, I wouldn't suggest that you expect a rise in their prices until the markets calm down.

DWA 1-yr chart

Disclosure: Author has no position in DWA.