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Writing Calls On Disney

|Includes: The Walt Disney Company (DIS)

05/06/13 Covered Call Pick: Walt Disney Company (NYSE:DIS)

The Walt Disney Company (DIS), commonly referred to as "Disney", is the world's largest mass media conglomerate by revenue, not only operating a host of studios and media channels, but their iconic theme parks and resorts. Founded in 1923, the company quickly became the leader in American animation industry with their iconic characters, like their mascot Mickey Mouse, recognizable around the world. Most known for animation and film studios, Walt Disney Studios and Pixar, the company also owns the ABC broadcast network, channels such as The Disney Channel, ESPN, A&E Networks, Lifetime, and ABC Family. They also acquired Marvel Studios in 2009, and Lucasfilm just last December, making them one of the largest, and arguably the strongest, media content provider in the world. They also license, publish, and sell a host of toys and products based off of their characters and content.

The Walt Disney Company has a market capitalization of $116.99 billion, with 1.805 billion outstanding shares.

The Walt Disney Company currently pays an annual dividend of $0.75 for a current yield of 1.2%.

With a beta of 0.91, DIS trades with approximately 10% less volatility than the current market.

Honestly we're not sure what else we really need to write here after you read that opening paragraph, but we'll give it a shot.

As you might have noticed, we're a big fan of searching for and recognizing trends in the global marketplace. The past few weeks our recommendations have involved two medial devices companies, recognizing the upcoming demographic shift that will cause these companies to become more profitable. Another trend we have recognized and discussed numerous times, is the move to mobile computing. People are using portable devices such as tablets and smartphones to do their computing and access the internet. That has been talked about at length, by us and by many others in our industry. What we haven't discussed yet, is what all these people are doing with their mobile computing. Far and above, the answer more often than not is: consume content. While some use their devices for work, because of how pervasive and integral the technology is in the modern household now, the average person uses their technological devices (mobile or not) for content consumption. It stands to reason then, the companies that control the most and the best content will profit. That's where Disney comes in.

Gone are the days when Disney was considered "just" an animation company. These guys are huge. Let's start with all the things you might not associate with Disney, but are some of the major reasons you should buy the stock. Some of the most profitable sections of the company most people don't know are under the Disney umbrella. The sports channel giant ESPN arguably has the best pricing power on cable, and receives some of the best ratings from NFL and NBA broadcasts. The A&E channel has some of the most popular and iconic shows on cable with Breaking Bad, Mad Men, and The Walking Dead topping ratings charts. Let's not forget ABC either, which has had recent hits in Revenge and Once Upon A Time. All of this strongly desired content comes out of Disney, and we haven't even gotten to anything that's stamped with Mickey ears yet.

Let's move to movies. The company has over 75 movies to gross more than $100 million in the box office, including the #1 opening-weekend movie of all time in "The Avengers" with $207.4 million. Their most recent hit is last week's "Iron Man 3" which came in at $175.3 million in the U.S. for the weekend, putting it in second place. The acquisition of Marvel Studios by Disney in 2009 has been a huge boon to the company, as the character and plot structure of the comic-book based world the studio builds their movies off of allows for greater audience investment as their favorite characters become intertwined in the cinematic world. The company paid $4.2 billion for Marvel studios in 2009, and the revenue generated from "The Avengers" ALONE paid for the acquisition. With a host of movies in the works out of Marvel Studios in the next five years, including "Avengers 2", the acquisition is looking to be one of the most profitable for a media company in a long time.

Speaking of acquisition, this past December, the company acquired Lucasfilm and thus the ability to tap into and extend perhaps one of the most iconic franchises in the history of cinema: Star Wars. With the first new Star Wars movie slated for 2015, we can't even begin to conceive of the possible boon this acquisition will have for the company, but we know its going to be big.

Oh, and they also own Disney and Pixar studios, the two most profitable animation companies in history. So there's that.

Here's what ties all that together. The company is able to monetize and market all of this wonderful desirable content through their theme parks, toys, video games, and product lines. While generally a huge expense on their bottom line, their parks act like huge interactive advertising campaigns that market their content across a surprisingly wide range of age groups. This more than makes up for the enormous operating costs of the theme parks as they pervade the sensibilities of their target audiences. Being able to go to an amusement park and interact with your favorite characters and storylines is not something to be overlooked, and is obviously a huge draw for younger audiences.

We can talk about the strength of the Disney content umbrella all day (like the deal with Netflix that is helping expose its content to children, and ties in with our initial comments about mobile content) but now its time to talk about the stock. Some say the company is expensive with a P/E of 21, but this is actually a 20% discount to the industry average of 26.4. While the company's price-to-sales, and price-to-book ratios are at a premium to the industry, these are due to the high operating costs of its theme parks and cruise ships, which we have already mentioned end up being a net positive for the company in the end. Analysts also expect a 13% increase in earnings per year for the next 5 years off of the strong content coming out of Pixar, Marvel, and Lucasfilm studios, so there is a tremendous amount of growth potential for the stock.

For a Covered Call Strategy we're looking to sell the July 2013 $70 Call. The reason for such a short duration on our Call is that the stock only pays a dividend once a year in December. That means you're not getting paid to hold on to the stock till the end of the year comes around. To help generate yield, while still having access to the growth potential of the stock, we'll be looking to generate quarter-like dividends by selling out-of-the-money Calls. This requires a bit more active management, but we believe will create better returns in the end. While the premium for the Call, repeating it multiple times throughout the year will yield a better annualized yield than the S&P 500. Also note, that while DIS reports earnings tomorrow, and generally trade down in reaction to reporting whether the results are positive or not, we see that as just another opportunity to add to the position. That is why we are recommending buying DIS and selling the July 2013 $70 Call.

Scenario:

 

  • Buy 100 shares of DIS @ $64.61 = $6,461 + Commission ($12.95) = $6,473.95
  • Write 1 DIS July 2013 $70 Call @ $59 - Commission ($8.70) = $50.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns.


Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration

(0.50)/64.74 X (365)/75

= 3.76% Static Return


If-Called Return:
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

(0.50 + 70 - 64.74)/64.74 X (365)/75

= 43.30% If-Called Return


Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

Posted by OaktreeAdvisors at 5/6/2013 10:14 AM
Categories: Weekly Picks

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Disclosure: I am long DIS.

Additional disclosure: At OakTree Investment Advisors, we are active managers and own positions in DIS and have written Covered Calls on some of our long positions.