Disney: 3 Positives From The Earnings Call

| About: The Walt (DIS)


Disney reported its first-quarter results Tuesday after the market close.

Earnings was a beat, while revenue missed consensus estimates.

Nevertheless, I highlighted three positives gleaned from the earnings call, and the need to monitor the pension and postretirement medical plan contributions which have become a major drag on FCF.

The Walt Disney Company (NYSE:DIS) used to have a streak of beating consensus estimates for both the revenue and the EPS. That streak ended in the third quarter of FY2015 for the Revenue side, and the second quarter of FY2016 for both the revenue and the EPS. Given the small EPS beat in the first quarter of FY2017 but the largest revenue miss in recent years, coupled with a decent share price appreciation in the lead-up to the results announcement, we should not be surprised that there would be some sell-the-news reaction. Furthermore, the forward guidance has been perceived by some as uninspiring.

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A Quick Overview of 1Q2017 Results

Parks and Resorts did well in the quarter, with revenues increasing 6% to $4.6 billion and segment operating income increasing 13% to $1.1 billion. Attendance at Disneyland Resort benefited from the marketing hype for the 60th Anniversary celebration. Disneyland Paris benefited from more operation days compared to a quarter ago while cost efficiency initiatives at the Hong Kong Disneyland Resort helped the bottom line. The cruise business registered higher growth thanks to higher average ticket prices and lower dry-dock expenses.

As we know by now, the performance of Rogue One: A Star Wars Story which was shown in theaters in the first-quarter of FY2017 could not be compared to that of Star Wars: The Force Awakens which opened in the prior-year quarter and achieved record opening weekend at the domestic Box Office. That inevitably dragged down the theatrical distribution results and consequently the Studio Entertainment revenues. Home entertainment results were primarily affected by the saturation effect with lower sales from the Star Wars Classic titles and Frozen franchise.

Consumer products-wise, the division suffered from another tough comps issue due to the strong sales of the Frozen and Star Wars merchandise in the prior-year quarter. The company only had the Moana merchandise to partially offset the decline. Like many other companies that have a sizeable overseas business, Disney was negatively impacted from foreign currency translation.

Finally, Media Networks, the biggest segment of Disney, had a slight drop in revenue but operating income declined double digits, decreasing by 11% year-on-year. The major culprit is, not surprising, ESPN, which continued to be afflicted with higher programming costs and lower advertising revenue, albeit partially offset by affiliate revenue growth.

Disney's share price has often responded in tandem with the changes in its Free Cash Flow. Hence, a 79% decline in Free Cash Flow from a quarter before is a concern. The company attributed the decrease to higher pension and post-retirement medical plan contributions in the quarter. This factor is nothing new as the company has stated the same in the past earnings announcements. However, this is the first time where there seemed to be such a big decline solely attributed to that reason.

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Three Positives from the Earnings Conference Call

Analysts, commentators, and investors have paid great attention to what plans the company has regarding ESPN. However, you would be left disappointed with the little new information revealed during the call. Robert Iger reiterated what was said during the last conference call, such as the launching ESPN on all new multi-channel services, including Sling TV, PlayStation Vue, DIRECTV NOW, and the soon to be launched Hulu. There is, nevertheless, a new unannounced but signed deal which The Wall Street Journal revealed to be with YouTube. The company remains firm in its intention to leverage its BAMTech acquisition to grow its Media businesses. By itself, the statement means little but Robert Iger said in the Q&A that he was "extremely excited about the prospects of" BAMTech, partly due to the potential for them to use data to increase or to generate great revenue from advertising, something that Disney lacks presently. This is a clear positive. In addition, a direct-to-consumer sports service offering from BAMTech is set to launch by the end of the year. The icing on the cake is that the service will have content not available on linear ESPN.

On the Studio side, Disney has a healthy pipeline of blockbusters. The next release is live-action Beauty and the Beast premiering in March. Early indicators (see comments by Robert Iger, Chairman and CEO of Disney) for the movie are pointing to a good showing at the Box Office. Unfortunately, as the current quarter (Q2, 2017) would be compared to the same period a year ago which benefited from the outperformance of Star Wars: The Force Awakens and the release of Zootopia, we should be prepared to see a quarter-on-quarter decline. Nevertheless, the pipeline for the rest of the year still looks good and if you are a long-term investor, that's what matters to you. In May, we will see the opening of Marvel's Guardians of the Galaxy Volume 2, another Marvel film promising "fantastic action and humor" that surpasses the original Guardian. Next in line would be an adventure film, Pirates of the Caribbean: Dead Men Tell No Tales. In summer, Pixar's Cars 3, with a brand new story and new characters, will be premiering. In November, Disney will release a brand new original story from Pixar - Coco, as well as Marvel's Thor: Ragnarok. Last but not least, Star Wars: The Last Jedi, otherwise known as Episode VIII, will open in December.

The anticipation and excitement around this movie is astonishing. The first trailer drew more than 127 million online views in the first 24 hours, breaking the record held by Star Wars: The Force Awakens. And the trailer we released last week also generated more than 100 million views. The first week of ticket pre-sales has also been very strong reminiscent of pre-sales for some of our biggest Marvel movies.

- Robert Iger, Chairman and Chief Executive Officer, The Walt Disney Company, on the company's upcoming movie, Beauty and the Beast.

For the Parks and Resorts, Shanghai Disneyland tasted early success for 2017 as the Chinese New Year festive season saw many locals thronging the venue to spend their long breaks. The resort reportedly operated at maximum capacity for "virtually the entire holiday period". The Q2 results will also benefit from one week of the winter holiday shifting into the quarter. However, with a later Easter holiday, which will now fall entirely in Q3 this year, whereas it fell in Q2 in 2016, Easter-related attendance will shift to the third quarter. Christine McCarthy, Senior Executive Vice President and Chief Financial Officer of The Walt Disney Company estimated the two shifts will have a net adverse impact of about $50 million to operating income in Q2 2017. Again, if you are a long-term investor, this is a non-issue. The key positive here has to be the opening of Avatar Land, an addition to the Animal Kingdom in Orlando, on May 27. The chairman and CEO described the attraction to be on "a very big land", and the experience to be "sizable". Attendance at the new attraction would be further supported when new series of the Avatar movie premiere in the future. This is a classic example of the Disney business model where customer participation in one segment leads to another. Besides ticket sales, attendees could buy toys and other consumer products. The positive experience at the Park would also keep their interest in the story alive and encourage them to catch the next Avatar movie. Guardians of the Galaxy would also be ready this summer at the Disneyland Resort in Anaheim.

[T]his year we'll open a great addition to Disney's Animal Kingdom with a brand new land called Pandora - The World of Avatar. Our imagineers have brought the breathtaking world of Pandora to life through astonishing feats of artistic genius and groundbreaking engineering. The result is an exquisite environment with phenomenal attractions and today I'm happy to announce this incredible new world will officially open on May 27.

- Robert Iger, Chairman and Chief Executive Officer, The Walt Disney Company


So while the Q1 results have been deemed as "uninspiring", there are three positives gleaned from the conference call: 1) potential for BAMTech to use data to increase or to generate "great revenue" from advertising, 2) continued strong pipeline of movies, spearheaded by Beauty and the Beast premiering in March, and 3) on the Parks and Resorts side, besides the strong start to the year recorded by Shanghai Disneyland, the upcoming Avatar Land addition to Disneyland Resort in Orlando as well as the Guardians of the Galaxy addition to the resort in Anaheim would stimulate future demand and bring spillover effects to the other businesses. Nevertheless, we need to watch closely if the pension and postretirement medical plan contributions continue to be a major drag as they did in the first quarter.

Disclosure: I am/we are long DIS.

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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Tagged: , Entertainment - Diversified, Earnings
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