Despite Analyst Downgrade Walt Disney's Future Looks Bright

| About: The Walt (DIS)

Analysts at Caris recently downgraded Walt Disney Co. (NYSE:DIS), a global entertainment company, to average from above average citing valuation reasons. The stock is up 40% since the start of the year and is currently trading near $51 after recently making a fresh 52-week high of $53.40. In a research note, the analysts mentioned that they believe the stock has limited upside potential and that it is fairly valued at $54.63, with their target price set at $55.

In a previous report on Walt Disney, we took a bullish stance on the company based on its diversified revenue base and positive outlook for its key business segments. We reiterate our previous stance. The company operates through five segments: Media Networks, Parks and Resorts, Studio Entertainment, Consumer Products and Interactive Media. Its three major revenue contributors are the media network, amusement parks and studio entertainment businesses which accounted for 46%, 30% and 12% of the company's consolidated revenues, respectively, as of the quarter ended June 30, 2012. 'The Avengers', a movie based on the Marvel Comics, was a smash hit on the box office which helped the company generate an operating income of over $300 million. However, the increase in revenues from The Avengers was largely offset by the sales of 'John Carter'. Operating income at Cable Networks increased to almost $2 billion in the third quarter, led by the growth at the various Disney Channels and at the ABC television network. However, ESPN showed some weakness which was largely due to the deferred affiliate fees, related to annual programming commitments. Overall, the company ended the third quarter on a positive note with quarterly earnings rising above 30%, led by higher spending at theme parks and, obviously, the success of 'The Avengers'.

As mentioned previously, the company's two growth engines are its amusement parks and media networks. Even though the company's amusement park business generated a 21% growth in earnings, it was hurt, to some extent, due to the timing of deferred affiliate fees for its cable TV networks. However, growth in affiliate fees can be expected going forward. Payment of affiliate fees, which accounts for almost half of the media network division's revenues, is expected to be sped up in the coming year as majority of its affiliation deals with cable networks are renegotiated. A few years back, the company signed deals with cable networks spanning eight to ten years, a majority of which will expire by the end of next year. Earlier this year, the company struck a deal with Comcast to provide sports, news and entertainment on television, tablets and smartphones. By the end of the current fiscal year, over 20% of its affiliation fees with Comcast will be renewed, which will definitely have a positive impact on the company's revenue stream.

Another major growth engine for the company, its amusement parks and resorts, also ended the quarter with impressive growth in revenues and earnings. Increased attendance at its theme parks, hotels and passenger cruise ships drove revenues up, and led to improved overall margins. Moreover, margin expansion is likely to continue going forward as the company's key investments start to pay off. The company's most recent projects, the Aulani resort and the Art of Animation hotels are doing well in terms of revenue growth. The recent improvement in occupancy rates is a testimony of that. All in all, margins of parks and resorts have improved recently and further expansion can be expected with the above mentioned projects operating at full potential.

As mentioned previously, the stock is down from its recent 52-week high of $53.40. However, we believe that despite the impressive earnings beat in the recent quarter, the drop in price is largely due to some profit-taking. The company's major growth drivers are its parks and media networks and they have shown impressive growth with visible margin improvement. Going forward, its upcoming projects like the Aulani resort and the Shanghai Disney resort will bring further increase in its margins. DIS doesn't look expensive based on its price to earnings multiple. It trades at 15 times its earnings compared to Time Warner Inc's (NYSE:TWX) 17.4x and News Corp.'s (NASDAQ:NWSA) 12.5x. We believe that higher revenues from amusement parks and resorts, as well as growth in affiliate fees expected from major cable companies, would bring growth in margins. These factors can be identified as catalysts for further growth in the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Telecom & Media Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.

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