Everyone knows Disney (DIS) as the land of Mickey Mouse and Donald Duck. Founded in 1923 by Walt and Roy Disney, the company's cartoon characters have become icons known around the world by millions of kids over the past 90 years.
However, investors should know that Disney is so much more than this. Besides theme parks and movies, the company is a media powerhouse since the successful purchase of ABC and other TV networks in 1996. In this article, I will present my thesis as to why Disney is a great long-term buy. The company presents a very good value to investors due to the impressive competitive moat it has built around its businesses over the past few decades.
Below is an overview of some key fundamental metrics for Disney:
Sales Growth (1 year)
Sales Growth (5 year)
EPS growth (5 year)
P/E Next Year
Return on Equity
Debt to Equity Ratio
The company has continued to grow both the top and bottom lines at steady rates over the past five years. The trailing and forward P/E ratios are also very reasonable upon first glance -- within range of the S&P 500 P/E, which now stands at 15.98.
Looking at the latest 10-K, we can see the breakdown of revenues and operating profits by business unit from 2011:
|Business Unit||Revenues||Operating Profit||Operating Margin||Growth in Margin from 2010|
|Parks & Resorts||$11.8B||$1.5B||13%||18%|
Some key takeaways from this breakdown are:
- 86% of operating profits come from the Media Networks and Parks & Resorts divisions of Disney.
- The Media Networks segment, which includes ESPN, The Disney Channel, ABC Family, SOAPNet, and A&E/Lifetime is really firing on all cylinders. The increases in revenues and profits were primarily attributed to higher advertising rates.
- Parks & Resorts and Consumer Products are also doing very well. The company reported increased consumer spending and the launch of its latest cruise ship in early 2011 as key drivers.
- Walt Disney Studios, although a well-known part of the business including several famous Hollywood movie franchises (e.g. Toy Story, Pirates of the Caribbean), is actually a small part of the overall business, and has unimpressive margins.
Going forward, I think there are several key drivers that should bode well for Disney's long-term prospects:
- Through its popular Media Networks, Disney has several strong brands, which should continue to expand and grow revenues and profits. ESPN is the real gem here. I will discuss this in more detail below in the competitive moat section.
- The key here is maintaining quality content that people want to view. The medium that people view it on (e.g., TV, internet, iPad, smartphone, etc.) will not be important as long as Disney continues to produce the programs that people want to watch. Then the company will be able to successfully monetize it. So far, so good here, as all networks continue to do well.
- A return to more historical growth norms in the U.S. and Europe, although not certain, would be a good boost for the Parks & Resorts and Consumer Products sections, which are more cyclical businesses sensitive to macro economic changes.
- The company has the balance sheet, cash, and free cash flow to make further acquisitions and continue growing the revenue streams. Evidence of this is the recent acquistion of Lucas Films for $4 billion. Star Wars brings another iconic franchise to the mix.
Business Risks To Consider
As with any company, there are always some risks to consider.
A lot of growth for the company in recent years has come from the big successes of ESPN. As time goes on, there is further competition expected for the network, as NBC Sports and FOX Sports really come at it head to head with improved programming and bigger budgets. Personally, I believe that the moat of ESPN has gotten stronger, not weaker, over the past decade, and I don't see this as a big threat in the near term.
Other risks could can be continued macro economic worries, including another recession. This will hurt margins in the cyclical businesses. For reference, in 2009, earnings dropped off 23% from 2008 during the great recession.
This is where I really feel investors should be excited about Disney. The brand recognition for the company is exceptional, and the company retains a strong economic moat, producing premium content that people around the world continuously want to watch. Indeed, this was a key basis for Kiplinger's in 2011 to call Disney one of the 10 best stocks in the world.
A recent article in Businessweek explains in detail the moat of ESPN. They dub the network the "Everywhere Sports Profit Network." With revenues growing at 9% per year, (about $8.2B in total for 2012), the network is a force in the media industry. ESPN takes in a whopping 1 out of 4 dollars earned by cable stations in America. The network charges $5.13/month per subscriber to each cable station. The industry average is only $0.20/month per subscriber! Talk about pricing power. Cable companies keep paying, as the viewing public cannot get enough of quality live sports TV programming. If you ask any American sports fan what the premium sports network is, I am confident that almost everyone would answer ESPN. Myself personally, I'm an American living overseas for many years, and I still find myself visiting espn.go.com almost every day to catch up on American sports. There is simply no other site or media outlet that is even remotely close to delivering the same level of quality sports content. Also worth considering -- live sports are unique in that they are a type of media content that people want to watch on big screen TVs with friends. In this sense, it cannot be replicated, as one network needs to control and produce the event. ESPN has put itself in a premium position to be that network in a majority of cases.
As a final note in this section, I won't spend time in this article to discuss in detail the moat around the iconic Disney characters. But suffice to say, I'm sure almost no one needs an introduction to Mickey Mouse and crew! Running now for 90 years and known in many cultures around the world, the traditional Disney cartoons and icons are as strong as ever, and remain a force to be reckoned with in children's entertainment.
Disney has a reasonably good record of shareholder friendly actions. Here are several points that I like:
- Disney pays a consistent, albeit modest dividend. The current yield is 1.2%, and the five-year dividend growth rate is over 14%.
- The payout ratio is less than 20%, and with continued steady earnings growth, investors can expect more dividend increases in the coming years.
- The outstanding share count over the past 10 years has been reduced by about 13%.
Predictable Earnings Growth
Disney has grown earnings per share every single year in the past 10, with the exception of 2009 during the great recession. The average CAGR over this period has been an impressive 14%. Going forward, I do not expect the same growth rates out of successful subsidies such as ESPN. However, the 24 analysts covering the stock do have a projected growth rate of over 12% in the next five years, and looking at the history of the company, I wouldn't bet against them to continue to produce steady returns.
Disney Has A Decent Balance Sheet
Disney has a debt/equity ratio of 0.35, which is well below the S&P 500 at 0.91. The company does have $15B in debt on the books, but this has stayed relatively steady over the past several years. There is over $4.3B in cash, and the company generates another $3.5B in free cash flow each year. Interest payments are covered more than 10 times by net earnings.
With a forward P/E of 14.4 and EV/EBITDA 9.3, at first glance, Disney seems to be reasonably valued. Certainly not downright cheap, but in no way expensive, either.
In terms of expected earnings growth, I think a good assumption would be to assume a rate of about 7% over the coming 10 years. With the company's strong competitive position, I don't see a significant drop-off in earnings. As analysts often are too optimistic and I do think there is a significant chance of a slower growth moving forward, I have taken 7% as a conservative figure and less than the 12% Wall Street predicts.
Using a simple DCF method:
- EPS: 3.02
- 10-year growth: 7%
- Annual growth rate after 10 years: 0%
- Discount Rate 6%
- Confidence Factor: 75%
With these inputs, I arrive at an intrinsic value of $65.33/share. This implies a 25% margin of safety from the current price of $50.32. In my DCF method, I have used a fairly low discount rate, which is my normal practice as I look at this as the "risk free" return percentage that I feel confident I could get if I deployed my capital in alternative investments. To compensate for this subsequently higher valuation, I then simply reduce the intrinsic value by multiplying it by a confidence factor -- how confident am I that these earnings will actually materialize. 0.75*$87.10 = $65.33. A popular alternative approach that some investors might use is to employ a higher discount rate instead. Although these methods are subjective, I do feel there is some margin of safety existing in the current share price. For sure, Disney is not a compelling value, but I would definitely say it is trading at a "good" price.
Disney is a wonderful company that will exist for decades to come. This is the kind of company that has built such strong brands over the years that you can feel immediately confident knowing it will continue to exist for a very long time. I think Disney is really a Buffett kind of stock. It is a great business, trading for a decent price, and any investor should love to hold it for years. I don't think the company trades for a compelling value, but it is one of those companies that will really compound in your portfolio over time. For the last 10 years, the stock is up over 300% vs. 156% for the S&P 500. I'll take those market-beating returns any day.