The Walt Disney Company: Beautiful Profits

| About: The Walt (DIS)
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Summary

Disney is riding the wave of the strong performance from its Beauty and the Beast remake.

The main attraction for Disney, however, is the prospect of lower tax rates. Disney's current tax rate is over 9 percentage points higher than the average for the S&P 500.

Assuming Trump's administration successfully pushes its tax agenda, and the corporate rate is negotiated to 20%, Disney would be a major beneficiary, with potential for 21% upside.

Analysis

Disney Profits from Live Action Beauty and the Beast

Proving that consumers' thirst for nostalgia isn't dead, Beauty and the Beast, The Walt Disney Company's (NYSE:DIS) remake of its highly successful 1991 animated featured, raked in $350 million in global box office receipts during its opening weekend, earning a March record earnings of $170 million in the United States alone. The film reportedly cost $300 million to make and market, meaning that the company has now seen a 17% return on its investment.

Beauty and the Beast's success vaults Disney up to third among major studios in Box Office Mojo's 2017 domestic box office league table, behind Comcast's (NASDAQ:CMCSA) NBC and 21st Century Fox (NASDAQ:FOX).

Disney ranked first in 2016, bringing in $3 billion in domestic earnings, and with more weekends of Beauty and the Beast to come - plus further installments to its popular Star Wars, Pirates of the Caribbean, Thor and Guardians of the Galaxy franchises to be released this year - 2016's record-setting run at the box office could very well be eclipsed.

Dividend

Disney stock has been on a steep climb of late, rising by 24% since hitting a 52-week closing low of $90.83 per share in mid-October. Consequently, its dividend yield has been depressed to 1.4%, meaning that a $10,000 investment will only pay $140 of passive income per year if Disney doesn't increase its dividend.

The company's dividend yield is inferior to that of the Dow Jones Industrial Average (NYSEARCA:DIA) and the S&P 500 (NYSEARCA:SPY), but is somewhat better than the average of its peer group.

What this means is that, while Disney may be preferable to its peers as investors build their dividend portfolios, the real "meat" will have to come from capital gains in the stock. Interestingly, despite its steep climb from its 52-week closing low, Disney's 8% climb in 2017 is only somewhat better than the S&P 500's 6%.

Tax: A Tale as Old as Time

Shortly after Donald Trump won the election, Disney CEO Bob Iger pushed for lower taxes, calling the tax code "ridiculously complex" and the corporate tax rate "too high." Before corporate tax inversions were neutered in 2016, Iger was one of the few high-profile American CEOs notable for publicly rejecting inversions.

That's understandable: Disney's annualized effective tax rate was 33.2% in its latest quarter, and it has averaged a 34.5% tax rate over the past four quarters. That's around 4 full percentage points higher than the average for the S&P 500, and it should be noted that Disney's fiscal first quarter tax rate was roughly 10 percentage points higher than the rate its large-cap peers paid during the period.

Trump's tax agenda calls for a reduction in the corporate tax to 15%, but recent reports suggest it could hew closer to the 20% proposed by Congress. What's more, its implementation could potentially be delayed to next year, considering that other parts of the administration's agenda are currently facing friendly headwinds.

Disney reported diluted earnings per share of $1.55 in its December quarter. During this period, it paid taxes of $1.24 billion on pre-tax income of $3.73 billion. Had the corporate tax rate been just 20%, the company's pre-tax earnings would have been $2.98 billion for earnings per diluted share of $1.86 - that's $0.31 of profit Disney could have earned. This is significant for dividend investors, since the company's payout ratio was around 50% in its fiscal first quarter. Essentially, Disney's high tax rate deprived dividend investors of $0.15 in additional dividends per share for the December quarter.

Looking back over the three quarters preceding Disney's most recently reported one, if the corporate tax rate had been a flat 20%, the company could have earned a cumulative $5.03 per diluted share over those three quarters rather than just $4.08. Consequently, holding Disney's latest payout ratio of 50.3% steady, investors could have gotten another $0.48 per share in cumulative dividends during this time frame - for a theoretical yield of 1.94% against its current share price.

That's an additional 54 basis points in yield that high tax rates are costing investors. It's an old tale from US corporates, but high taxes really are bleeding value away from shareholders.

Conclusion

What's interesting about Disney is that even if Trump's plan to reduce corporate taxes doesn't come into effect until 2018, the company will still benefit from it greatly, considering the slate of films it has planned for 2018 and beyond, including further installments in its billion-dollar Avengers franchise and more movies from its Star Wars cinematic universe. It's also possible that the success of Beauty and the Beast could bode well for for the company's upcoming Snow White and Aladdin remakes.

On top of this, Disney continues to invest in its theme parks, leveraging more recently acquired properties such as Star Wars and Marvel to offer new attractions for the current generation of park-goers. On the TV front, the company has long-term contracts with both the NBA and the NFL through ESPN and ABC. The former, in particular, is on the upswing, with last year's NBA Finals breaking records for ABC.

Disney is currently anticipated to earn $6.82 in 2018, implying a forward ratio of 16.5x earnings, which is moderately lower than the 18.4x multiple of the S&P 500. However, most analysts are conservative and haven't yet anticipated the introduction of a 20% tax rate (at least), and we believe that, given Disney's prospects, the stock should be trading at least on par with the S&P 500, if not at a slight premium.

Thus, if we assume that a 20% is negotiated and implemented halfway through 2018, we get a hybrid tax rate of 26%, which would imply earnings per share $7.42 per share. Multiplying this by the market's forward multiple of 18.4x, we get a target price of 136.56 per share.

This means investors could be looking at 21% upside for the stock. Including Disney's current dividend yield works out to a total return of 22.4% - a strong return for a media company, and a reason to buy the stock today or during a market pullback.

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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.