Disney: Riding The Success Of 'The Avengers' To Future Earnings Growth

| About: The Walt (DIS)

It's safe to say that the last week and a half have been huge for the House of Mouse. As everyone knows, The Avengers shattered the record for domestic box office sales at $207 million, and this past weekend it became one among a handful of films to gross over $1 billion internationally. While setting a new standard in opening weekend sales, The Avengers also became the first substantial vindication of Disney's (NYSE:DIS) purchase of Marvel Comics, announced in 2009. I have mentioned this before, but Paramount retained the distribution rights to Marvel movies up to this point, which included the first two Iron Man movies, Captain America, and Thor. But from here on out Disney will hold these rights and the prospect of such is very encouraging.

In other big news, Disney announced their second quarter earnings last Tuesday at $0.58/share. This was significant because it was an 18% rise in earnings over the same quarter last year. That quarter had been the last time Disney had missed an earnings consensus in the recent future, and it was to the tune of 14%. Over the last year, and especially the 2 quarters announced in 2012, Disney has shown a monumental increase in earning.

However, Disney's stock price has not necessarily been in line with their earnings success. Last August, Disney dropped roughly 25% of its market capitalization and stayed in the $30-$32 range until the time leading up to their November earnings announcement. It was around this time that I claimed that the stock could not drop much lower. Since October the stock price has run up about 50%, from $30 to $45.

Click to enlarge.

This, of course, yields the question: is $45 too much to pay for Disney - are they likely to fall back down? In other words, can Disney continue to improve upon their many different sectors, or have they tapped out? Based on this recent performance and a few other reasons, I personally feel that Disney has both the opportunity and capacity to grow future earnings. There are two global reasons for this. The first is that Disney is an industry leader in regards to almost all of their segments, and as such, they realize that they have to continue to innovate to fend off competition. Second, Disney is very dependent on the strength of the overall economy, and while Europe is falling apart, the United States is continuing to make strides out of the recession. With this in mind, let's examine some of Disney's biggest money-makers.

I'll begin with movies since it was mentioned above. With as great as The Avengers has done in the box office, it does not erase the fact that John Carter was the biggest flop of 2012. I haven't seen this film, but I think the average American would tell you that a Civil War veteran has no business fighting a war on Mars. The logistics don't support it and I would hope that war on Mars will have advanced passed soldiers standing in a straight line firing into an opposing straight line. Regardless, the movie lost a lot of money and more importantly it was not very kid friendly.

Disney has a business plan with their films, especially the Pixar ones, where they hope that sequels are feasible and that children will buy toys and anything else with the movies' pictures on it. The best example would be Cars and Toy Story for animated films and the Pirates films. All of these have generated significant revenue outside of ticket sales and set up long-term franchises. And with the Marvel purchase, Disney has worked itself into some huge franchises. For instance, Iron Man 3 will be released in 2013, as well as Thor 2, Captain America 2, and the Avengers 2. Outside of the Marvel films, the next Pirates and The Muppets 2 will come out in 2013, along with Tron 3 in 2014, and one Pixar movie a year for the foreseeable future. So with this lineup, it is safe to say that movie revenues should meet and exceed expectations for the next 3-4 years.

Disney's largest segment is television. They are of course the primary owners of ESPN, ABC, Disney Channel, and every derivation thereof. That probably covers well over a dozen channels just on average cable subscriptions. Disney also owns 40% of the History Channel/A&E block of channels. As discussed above, ESPN is an industry leader. They have no real competitors other than the sport specific networks. By using the term 'real' I am not including the new NBC Sports Network. Hockey is really the only sport I watch, and watch religiously, so I find myself on NBC Sports quite often, and basically never on ESPN because of their vendetta against the sport, but I am well aware that I am in the minority. ESPN rakes in cash and NBC Sports will be relegated back to cycling and fishing once hockey is over. Speaking of relegation, ESPN was the only channel to watch the Man City game this Sunday. And because ESPN is an industry leader, advertisers are lined up waiting for airtime. This is another example of how Disney's revenues will continue to pick up as the economy improves.

Clearly the most economy-reliant division of Disney are their theme parks. The American parks are well grounded in our nation's culture and stand as an exemplar to all others. Few other parks can get away with charging you that much for every little thing, and then get you to spend all of your time in Disney-owned hotels, restaurants, and shops. As far as future earnings go, there is a park under construction in Shanghai and Disney has just recently introduced its newest cruise ship, the Disney Fantasy.

To me it appears that Disney is still a buy even at the $45 mark. At this range they are still only trading at 16 times earnings, which is basically in line with media companies like Time Warner (NYSE:TWX) and entertainment companies like Cedar Fair (NYSE:FUN). Given an appropriate P/E, as long as earnings continue to rise as expected, price should follow suit. Right now, earnings are expected to rise between 15-17% over the next 3 years. That with a meager 1.3% dividend on top would make for a pretty sound and safe investment that can be fun to follow.

Disclosure: I am long DIS.