The Best Of Times And Worst Of Times For Disney And Shareholders

| About: The Walt (DIS)

Summary

Disney reports record first quarter earnings, but shares hit new 52 week lows.

Company's five year historical price to earnings ratio is 18.7.

Impact of Star Wars even higher than expected by company and analysts, a bullish sign of what's to come.

It seems appropriate to use the classic antithesis quote from the classic Charles Dickens A Tale of Two Cities when describing Disney (NYSE:DIS) stock. The giant media conglomerate reported first quarter earnings that broke company records and came in well above consensus estimates. Despite the record quarter, shares of Disney continue to fall to new lows. Once again investors are ignoring value and growth hear, due to the extra emphasis being put on ESPN.

Here is a look at how the first quarter fared for all segments:

Revenue

Operating Income

Media Networks

$6.33 billion, +8%

$1.41 billion, -6%

Parks/Resorts

$4.28 billion, +9%

$0.98 billion, +22%

Studio Entertainment

$2.72 billion, +46%

$1.01 billion, +86%

Consumer Products/Interactive

$1.91 billion, +8%

$0.86 billion, +23%

The chart gives a clear picture of how good the quarter was for Disney. The company saw growth of at least 8% across all four major segments, including a phenomenal 46% increase in the studio segment led by the record breaking blockbuster "Star Wars: The Force Awakens". Operating income was also exceptionally strong with three of the four units not only seeing increases, but improvements of more than 20%. Media networks declined 6% due to higher spending and the timing of College Football Playoff games on ESPN channels.

Disney reported adjusted earnings per share of $1.63 for the first quarter. That represented growth of 28% from the prior year. This also came in well above a consensus estimate of $1.45 from analysts. In fact, not even the most bullish analyst tracked by Yahoo Finance saw this earnings figure coming. Yahoo lists a low to high estimate range of $1.27 to $1.55.

Earlier this year, Disney was selected as one of my top ten stocks for 2016. My three key reasons were: having two Star Wars movies release in fiscal 2017, theme park segment getting a boost from China and new expansion, and shares being undervalued based on their five year trading average.

The first reason is now no more thanks to the shifting of "Star Wars VIII" to December of 2017, rather than its summer release. Consider me extremely bummed by this as I believed I was ahead of the game in calling out this overlooked piece of bullishness. The shift won't have a huge impact on fiscal 2017, as I believe early estimates are bullish, but I would back away from my $6.50 2017 targeted earnings slightly.

The big gain in studio entertainment shouldn't be a big surprise for anyone watching "Star Wars: The Force Awakens" break records and see strong global. The move has grossed more than $900 million domestically and $2 billion worldwide. Disney had three of the top four grossing movies in calendar 2015. The company ranked second in the U.S. with a 19.8% market shares and $2.28 billion in box office revenue from 15 movies.

The contribution from Star Wars is far from over. There will be a movie every year, offsetting between the continuing storyline (VII, VIII, IX) and original movies (Rogue One, Han Solo). Disney stated on the earnings call that Star Wars merchandise has sold well every year even though it had been more than 10 years since a movie was released. The merchandise and licensing power of Star Wars exceeded the company's expectations and sets up for a strong future. Global retail sales of Star Wars related merchandise was more than $3 billion in the first quarter. Licensing revenue for the company was up 23% in the quarter, with Star Wars a big part of the reason. Also remember that Disney is demanding a higher cut (60% vs 50%) of box office revenue from theaters for its large blockbusters (Avengers, Star Wars). This likely contributed to the sharp increase and above consensus numbers in the first quarter.

On June 16th, Shanghai Disney will open to the public. This highly anticipated international park could prove to be a major catalyst for Disney in 2016 and the future. The company has seen several delays and rising costs to get the park open in the most populous country. The month of June will be in Disney's third quarter. The fourth quarter of fiscal 2016 will include three full months of operating results in China, which should provide a decent forecast for how this park is going to perform in fiscal 2017.

The first quarter showed the strength of the parks and resorts segment with strong revenue and a 22% increase in operating income. Strong park attendance in domestic Disney parks (+10%) and higher guest spending was the big factor. However, the fact that the Disney Cruise Line had its best first quarter ever, and a 92% occupancy at Disney hotels is worth noting and could help this segment outperform throughout the year.

In regards to ESPN, the company is seeing the continuing shift of cord cutters. However, ESPN also benefits from being one of the most demanded channels by consumers, which explains why the Sling over the top offering from DISH includes ESPN. On the call, Disney said it has seen an uptick in ESPN subscribers over the last couple of months.

Disney mentioned it expects to continue innovation and pursue new distribution opportunities. It says this with confidence given its huge properties of Marvel, Pixar, Star Wars, and ESPN. Those four right there could form an over the top service that could dominate. Disney was also asked about splitting the company into two with media being one piece and the rest forming a new company. The company said it isn't happening and I think should really be put to rest. These units are too complimentary to each other. The impact of Star Wars was seen impacting all segments and will continue to do so in the future. Disney investors are stuck taking the good and bad that come from ESPN. In my opinion, that's not so bad. ESPN has the rights to the biggest sporting events, and while that leads to higher rights spending, it will come full circle with higher advertising revenue. Live sports are one item that are hard to DVR or cut the cord because of.

Going forward, Disney has exciting growth across its major brands and some upcoming projects. Star Wars, Marvel, and Pixar will lead the way. The company also has projects with Disney Animation (Zootopia), a Braodway version of Frozen (2018) and television special based on Frozen (2017). Marvel has a strong slate scheduled with "Captain America: Civil War" and "Doctor Strange" scheduled for 2016, two movies coming in 2017, and three Marvel movies hitting screens in calendar 2018.

Shares of Disney closed at $88.85 on Wednesday. Earlier in the day, shares traded as low as $86.25, a new 52 week low for the stock. Shares have now traded between $86.25 and $122.08 over the last 52 weeks. The biggest question here seems to be valuation. How should investors value Disney? Is it still a growth stock? What multiple should be given to a stock expected to grow 5 to 6% annually the next two fiscal years?

As I mentioned back in January, Disney has a five year price to earnings multiple of 18.7. Given today's drop, shares now trade for 15.7 times expected fiscal 2016 earnings per share of $5.66. Going forward, shares now trade for 14.4 times expected fiscal 2017 earnings per share of $6.17. The company has already come in ahead of forecast for the first quarter, which means that the $5.66 figure could start to trend higher. I even hinted that Disney could earn more than the $6.17 in fiscal 2017 as well. Taking the average multiple of 18.7 times the $6.17 for fiscal 2017 nets a price target of $115.38, or 30% upside from Wednesday. Earlier this year, I gave a price target of $120.96 based on the multiple of 18.7 and $6.50 in earnings per share. Due to the timing of "Star Wars VIII", I am now more comfortable recognizing the estimate of $6.17 for 2017 earnings per share.

The other question might be what analysts do with the latest earnings report. Analysts started lining up new calls in January, with the majority of the discussion tied to ESPN. Barclays cut shares to underweight with a price target of $89, down from $98 previously. JPMorgan called shares extremely attractive in January, calling ESPN fears overblown. I would expect to see some new calls and price targets start to trickle in, and once again likely coming on both sides of the argument.

I didn't hear anything on the earnings call to make me lose my optimism for Disney over the long term. While there was some likely profit taking happening, investors may just be getting out for higher growth names. I think investors are getting an extreme bargain here and we have only begun to see the monetization of the Star Wars brand.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DIS over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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