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Disney - Media Marvel keeps on rolling

Nicholas Hyett | 9 May 2019 | A A A
Disney - Media Marvel keeps on rolling

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Walt Disney Co Common Stock

Sell: 151.46 | Buy: 151.49 | Change 5.51 (3.77%)
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Disney's second quarter revenues rose 3% to $14.9bn, with profits ahead of market expectations.

However, operating profits of $3.8bn were still 10% below the same quarter last year, as investment increased in the direct-to-consumer business and the success of Black Panther and Star Wars: The Last Jedi last year made for a tough comparison.

The shares rose 1% in after-hours trading.

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Our view

A slightly light film schedule, increased investment in the theme park and streaming businesses and cost associated with the Fox merger all held back profits in the first quarter. But Disney's a business for the long term.

A vicious bidding war with rival Comcast meant the Fox deal ended up costing more than the group would have liked. But the deal stacks up nonetheless, and disposals, of Sky and Fox's regional sports networks, should give the balance sheet a much needed cash infusion. That should set Disney up nicely for the next stage in an aggressive corporate expansion.

CEO Bob Iger is splashing the cash on new Marvel and Star Wars attractions at theme parks. Guests have continued to queue up at the gates despite recent hikes in ticket price, and that's before many of the new attractions come online. A portfolio of hotels and cruise ships helps to feed the apparently instantiable demand for all things Disney.

The soon to launch streaming service, Disney+, is also soaking up cash and is a whole new world for Disney. The competition here is formidable. Netflix is spending over $13bn a year on content, and Apple's just entered the fray.

Disney has several major advantages over its younger rivals. A back-catalogue to die for, $9.8bn a year of free cash and some of the best copyright on the planet.

It would be foolish to dismiss the challenges ahead though. Despite early forays with Hulu and ESPN+, Disney lacks Netflix's digital expertise. And mega mergers like Disney/Fox come with lots of execution risk, not least that key staff are lost in the transition.

A wave of optimism following the completion of the Fox deal and Disney's recent investor day, which focussed on streaming, has seen the company's PE ratio shoot up to 20.6 times. That's well above the longer term average of 16.1 and has pushed the prospective yield down to 1.2%.

Despite the hefty valuation we continue to be impressed by Disney's strength in depth. The group's ability to take intellectual property generated in the studios business, and package that for consumers across numerous platforms is hugely valuable. With integration of the Fox assets only just getting started, and Disney+ set to provide yet another route to consumers, management are enjoying an embarrassment of riches when it comes to opportunities.

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Second Quarter Results

Revenue from Media Networks was broadly unchanged in the second quarter at $5.5bn. That reflects revenue growth in Cable Networks, led by ESPN, offset by a decline in Broadcasting, where programme sales and advertising revenue both declined. Operating profits in the division fell 3% to $2.2bn as Broadcasting saw a significant increase in programming costs.

Parks, Experiences and Products saw revenues rise 5% to $6.2bn, with operating profits up 15% to $1.5bn. Progress came despite a negative impact from the timing of Easter, and reflects a strong performance from both resorts and theme parks, while the consumer products business, which was boosted by the launch of Kingdom Hearts III.

Disney's Studio Entertainment saw revenues fall 15% to $2.1bn after an exceptionally strong quarter in 2018. Operating profits fell 39% to $534m.

The growing Direct-to-Consumer & International business saw revenues jump 15% to $955m, although operating losses increased to $393m. Increased losses reflect ongoing investment in ESPN+, Disney+ and the consolidation of Hulu.

The acquisition of a further stake in Hulu from Fox means Disney now has a majority stake in the streaming business. Its original 30% stake has been revalued as a result, resulting in a $4.9bn one off gain.

Capital expenditure increased 16.9% year-on-year, to $2.4bn, largely as a result of investment in the group's theme parks. Free cash flow fell 21% to $2.3bn, reflecting the increased capex and lower operating profits.

Borrowings increased by around $36bn over the period, following the completion of the Fox deal.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.