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Walt Disney - Increased investment dents profits

Nicholas Hyett | 7 August 2019 | A A A
Walt Disney - Increased investment dents profits

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Walt Disney Co Common Stock

Sell: 177.12 | Buy: 177.16 | Change -6.32 (-3.44%)
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Walt Disney reported a 33% increase in third quarter revenues, hitting $20.2bn, following the acquisition of 21st Century Fox. Underlying operating profit fell 5% to $4bn as the company ramps up investment in its direct-to-consumer businesses - Disney+ and ESPN+.

The shares fell 2.8% in aftermarket trading.

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Our view

The integration of 21st Century Fox, and investment in new streaming services mean second quarter results were a little disappointing. But given all the moving parts we'd encourage investors to take a long term view. Disney's business model is designed to deliver over decades not months.

A vicious bidding war meant Fox ended up costing more than Disney 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 would 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 generally continued to queue up at the gates despite recent hikes in ticket prices, 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. The service is expected to launch before the end of the year - so something to keep an eye on.

Disney has several major advantages over its younger rivals. A back-catalogue to die for, $9.8bn of free cash last year, and some of the best copyrights 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 21.9 times. That's well above the longer term average of 17.3 and has pushed the prospective yield down to 1.3%.

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 it 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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Third Quarter Results

Media Networks remains the largest contributor to revenues and profits, at $6.7bn and $2.1bn respectively in the quarter. The Cable Networks division benefitted from the inclusion of 21st Century Fox channels FX and National Geographic, although ESPN also delivered growth in advertising and affiliate revenues. Increased Broadcasting revenues were driven by the 21st Century Fox acquisition, but falling ABC programme sales meant operating profits fell 17%.

In Parks, Experiences and Products the group saw revenues rise 7% to $6.6bn, with operating profits up 4% to $1.7bn. Domestic parks and resorts were relatively weak, as visitor numbers fell and costs increased following the opening of Star Wars: Galaxy's Edge. However, that was offset by strong Toy Story merchandise sales and a good performance at Disneyland Paris.

Studios saw revenues rise 33% to $3.8bn, with operating profits up 13% to $792m. That reflects the strength of Avengers Endgame, Aladdin, Captain Marvel and Toy Story 4, although the 21st Century Fox business reported a loss on Dark Phoenix.

The fledging Direct-to-Consumer & International business saw revenues rise 367% as Hulu, Fox, National Geographic and Star India were included for the first time. However operating losses increased to $553m on higher investment and the full consolidation of Hulu losses.

Net debt increased 208% year-on-year following the Fox acquisition to $51.5bn. Free cash flow during the quarter fell to -$2.9bn following certain tax liabilities from the Fox acquisition.

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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 for more information.