by Clement Thibault
The Walt Disney Company (NYSE:DIS), a global entertainment enterprise, reports Q3 '16 earnings on Tuesday August 9, after the close.
1. Earnings and Revenue forecast
The Walt Disney Company is expected to report earnings on Tuesday after the closing bell. Wall Street's estimate for DIS is $1.61 EPS on $14.1B in revenue. This would mean YoY growth of 11% in EPS, up from $1.45 during Q3 of FY15, and 7.6% growth in revenue from Q315.
While Wall St. evaluates the company as a single entity, a breakdown by corporate segments makes it easier to identify core businesses and better understand its growth drivers. It should be noted that Disney has been shifting the dates regarding how it identifies its quarter end, making it difficult to compare quarters. For example, Q1 FY15 for Disney ended in December 27, 2015, while Q1 FY16 ended on January 2, 2016. This makes a big difference in considering results from such high viewership events as the College Football Playoff which fell in between those two dates.
2. Media Networks
Walt Disney's media networks are without question the most important factor in evaluating the company overall. Disney's media network includes the ABC Television group, sports cable network ESPN, as well as a 30% stake in streaming service Hulu (which it co-owns with NBC, Fox and Time Warner Cable). This division accounts for 44% of Disney's entire revenue, and 60% of its total operating income. As evident by the disproportionate ratio between the revenue and the operating income percentages, this is also the segment with the best operating margins, at 39%. While this may seem like good news, some of the bump in operating income came because of the timing of the College Football Playoff, with fewer games being played in this year's current quarter, thus resulting in decreased programming costs for the quarter.
The more urgent question for this segment though is what is going on with ESPN's subscribers? According to multiple sources, ESPN is losing subscribers at an alarming rate. DIS continues to remain mum on the subject. However, according to Nielsen estimates, there are currently about 88 million ESPN subscribers, 11 million fewer than two-and-a-half years ago, and 4 million less than at the end of fiscal 2015.
With escalating operating costs as broadcast contracts with the NFL, NBA, and other major league sport franchises become costlier, this deficit is becoming a gaping question mark. It appears that most of the subscription losses are a result of 'cord cutters' and 'cord shavers', people who switch to streaming services or cheaper, "skinny bundles" of basic services. Disney is trying to counter this trend by negotiating with distributors in hopes of being included in less expensive TV or cable packages, such as the recent partnership with SlingTV, a subsidiary of DISH Network (NASDAQ:DISH). So far, there hasn’t been significant progress, but it's arguably the most important figure to monitor going forward.
3. Parks and Resorts
This is Disney's second largest segment, bringing in 30% of the company's revenue during the last quarter. Disney currently operates 6 branded, Disneyland parks worldwide: one in France, two in the US and three in Asia. It also administers over 30 hotels and resorts globally, most affiliated with the parks. However, with high operating costs, margins from this division—at 15%—are significantly lower than from the networks. Of particular interest this quarter is the opening of the newest Disneyland in Shanghai, on June 16th. The Shanghai Disney Resort, a joint venture between Disney (at 43%) and a consortium of Chinese companies owned by the Shanghai government (at 57%), is estimated to have cost over $5.5 billion dollars, and is three times larger than Disney's park in Hong Kong.
Disney has managed to grow guest spending at all the parks by raising ticket prices, resulting in an operational income increase for the last quarter of 10%. Still, the biggest individual story remains the park in Shanghai. With just a few weeks' worth of numbers, we believe it still might help paint a picture for the rest the Parks segment.
4. Studio Entertainment
Disney's movie segment will benefit from strong performances of three of the movies it released in the past quarter. Captain America, The Jungle Book, and Finding Dory brought in $1.15B, $940M and $834M in revenue respectively. However, this segment is rather volatile; When analyzed on a quarterly basis, given that theatrical releases are special events which do not reliably occur each quarter, it's difficult to count on steady, stable, quarterly injections of revenue from this division. Still, this quarter, the three releases above will compete nicely with last year's numbers from Avengers: Age of Ultron, which made $1.4B in sales.
Longer term, since Disney owns Marvel Entertainment, Pixar Animation Studios, and Lucasfilm, its ability to keep on pumping out blockbusters appears to be safe.
Conclusion
Clearly, Disney's biggest worry going forward is ESPN. It's a costly product for cable and satellite providers, with its $6.10 monthly fee per subscriber. Losing millions of subscribers year-after-year is certainly not sustainable, especially in a market which values growth. We've already seen the negative impact of Netflix's (NASDAQ:NFLX) slow earnings growth earlier this earnings season. Social networks such as Twitter (NYSE:TWTR) and LinkedIn (NYSE:LNKD) also got hammered on their slowing growth rates. Still, Disney has been able to successfully drive its operating profit up despite declining subscription numbers for over five years now.
During Disney's last earnings call, CEO Bob Iger said that the launch of ESPN as part of the Sony Vue and SlingTV packages contributed "incremental subs" for ESPN. Yet as mentioned earlier, the latest Nielsen report doesn't show an improvement and even indicates the opposite. Still, at $95 per share, with a P/E ratio of 17, there's an adequate balance between DIS's ESPN problem and the valid expectation of revenue growth from the parks as well as additional, future box office successes.
But to justify a rise in its stock price, Disney must be able to show growth across the board, or from a new, as yet untapped and unexplored revenue source. Unfortunately there just doesn’t seem to be this kind of major growth driver in Disney's arsenal at the moment, nor any exciting new opportunities on the horizon. Therefore, we wouldn't be surprised to see Disney continue to struggle in its current price range.