Disney's Fiscal Second Quarter: No Magic, But Business Remains Attractive

| About: The Walt (DIS)


Disney's Q2 results are out, and the quarter was a quiet one.

The top line missed analyst consensus, but the bottom line came in ahead of expectations.

If one looks at the numbers, there is still a lot to like; the company's brands bring in the bucks, quarter after quarter.

One thing to note: ESPN is probably still a concern, but I doubt CEO Bob Iger wants to sell it.

Those expecting Disney stock to rocket past $120 in the very immediate future might be disappointed; it may take more time for the stock to once again grab significant momentum.

Disney (NYSE: DIS) reported results for its fiscal Q2. It was a quiet quarter with not a lot of magic in sight, but it nevertheless confirmed the company's standing as a major media conglomerate worth a look for the long term.

The top line missed analyst consensus, coming in at $13.34 billion -- that was $110 million less than expected. However, the top line was ahead by nine pennies at an adjusted $1.50 per share.

Let's go to the press release. The media networks division of the company gets all the attention (and because of its size, it's for a good reason). Yes, it's the segment that contains the dreaded ESPN conundrum. The growth here was disappointing for both the quarterly and six-month frames. Revenue for the three-month period rose 3% and it was flat on the six-month period; operating income for media networks dipped 3% during both the three-month and six-month frames.

Parks/resorts saw top-line jumps of 9% and 8% for the three-month and the six-month periods, respectively; profit for both those frames was up in the double digits. The studio asset had no revenue growth in the last two quarters, and its profit dipped in the six-month frame, but the second quarter saw a nice operating income rise of 21%. Consumer products/interactive media didn't do that well for both quarters.

Yes, it was a quiet, boring quarter. Here's what I see.

Let me take the studio division first. There is going to be variability there, rough comparisons year-over-year, etc. Still, I would like to see that division constantly on the rise, even though I know it isn't meant to be. You have to keep your eye on the long-term, though; the company will be releasing a lot of hit movies not only in the coming years but during this year alone. Guardians of the Galaxy Vol. 2, for example, is doing strong business right now, and it is an important property for the company. My hope is that Disney is doing its best to somehow grow that business quarter after quarter. That might involve releasing more tentpoles in a calendar year, or reducing budgets, etc. Management should exploit its data collection to see what it can do to better produce and market its cinematic trademarks.

The parks/resorts division is perhaps the core asset of the company, and I see good things for it in the future. As far as theme parks go, Disney is the one brand with which consumers feel they must interact. I don't see that changing. The section of the theme park dedicated to Star Wars will drive ticket sales and resort stays in a very shareholder-value-enhancing manner when it arrives. I am very confident in Walt Disney World, Epcot, the overseas parks, the cruise vessels, etc. They are capital-intensive, but it is a good investment.

Consumer products/interactive media -- not much to say here. Q2 wasn't exciting this time around, but that doesn't mean the company won't grow its product-licensing business over time. One problem the company has always had in this area is with video games; Disney really miscalculated its strategy as it concerned producing and distributing interactive entertainment (e.g., the whole Infinity failure). As a shareholder, the lack of success with video games annoys me, but the company is now doing what it should do -- focus on licensing its IP, not on buying game studios. Remember when the company used to do that? Even when the gaming industry wasn't contracting I questioned that approach. That's all over, so hopefully over time the interactive division won't be so much of a drag. The important thing about consumer products is Disney sells quite a bit of merchandise every year, and I anticipate it will be a growth business. Star Wars, Pixar, Marvel, Mickey Mouse, Frozen -- the product licenses will keep on coming , and the products will keep on selling.

Now, let's turn to media networks. We all know the issue -- ESPN. Subscriber numbers apparently are down. Disney said in its press release that, specifically, it was a decrease at ESPN that helped to drive the decline in operating income in the cable-networks portion of the media networks division. Digging down deeper, ESPN was challenged by higher costs for programming; an increase in affiliate and advertising revenue helped to lessen that blow. However, that affiliate revenue growth was based on an increase in rates for contractual reasons. Here's what you know is coming, the big problem everyone talks about: balancing that contractual growth out in an unfortunately negative manner was -- you guessed it -- a decline in subscribers. How bad the decline was, the press release does not reveal. It's simply enough to say that a decline was involved.

There are a couple things I think about this. First, ABC probably needs to work harder to cover up the ESPN issue. The broadcasting portion of media networks did well -- quarterly operating income jumped 14% -- so I'm sure some are questioning this statement, but truthfully, if Disney is going to keep ESPN and ride that problem out, then the major network will have to become an even more efficient producer/distributor of quality content that can always persevere in any volatile advertising marketplace. The company's exposure to advertising is obviously still significant, so I feel that is something to consider, both for management and shareholders alike.

Second -- and you knew this was coming as well -- we need to think about whether a transaction involving ESPN will ever materialize. Here's my thought process about that. CEO Bob Iger is considered one of the greatest chief executives of his time, and maybe of all time; I'm not sure I'd fully agree with that, but yes, he bought some very value-adding assets. Put yourself in his position -- he recently extended his contract, he's worried about his legacy, and he's trying to find the next CEO for the company. Imagine trying to find a buyer for ESPN with all that going on? I'm not saying he can't do it, or that he shouldn't do it -- I'm about ready for an ESPN transaction myself -- but I can't imagine he would want to do it. The dread and worry over doing that transaction incorrectly, or that the transaction was the incorrect thing to do in the first place, probably places a large amount of intellectual friction in the process of considering the idea.

Therefore, I just don't see it happening right now. If we are to see a transaction involving ESPN -- a sale, a decrease in ownership -- I'm assuming it may happen with the next CEO. Put yourself in that person's eventual place -- after reading so many think pieces about spinning off Disney's big problem and then concentrating on all the company's great consumer-products-promoting IP, one might imagine that Disney's next chief will say to herself, "Let's do it." It would make a mark immediately, it presumably would drive up the stock price, and it would be a lot of fun. It would give a great feeling of power. Iger's simply at a different point in his corporate career, he's too far along to want to take any significant risks to grow; he wants to preserve legacy capital, not roll the dice with it. And besides, he is a great buyer of things, not necessarily a great seller.

As for the stock, I think it's possible that it could be stuck for a while. The level I would like to see it rise above, and stay above, is $120. I'm not sure that will happen in the immediate future, but of course keep in mind I have no power to predict the future; anything can and will happen. I still view the stock as a core long-term holding based on Disney's business model of competently managing valuable IP, as well as its willingness to appropriately invest in its iconic theme parks. But there may be some short-term pressures on the shares. Until there is news on the next CEO, it's possible Wall Street may withhold its full support.

This quarterly report, while not the best, does not dissuade me from holding on to the stock or from having confidence in Disney.

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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