Disney–waiting for the upturn; Dec 09 results

First-quarter results–up 15%

DIS reported its December-quarter (first quarter of fiscal 2010) earnings results on February 9th.  Excluding unusual items, earnings per share were $.47 this year vs. $.41 last year.  That’s a gain of 15% over the deep-in-recession performance of 12 months ago.

The investment case for DIS…

…assuming there is one (I own the stock, so I must think there is) rests on three ideas:

1.   ESPN continues to motor along in the US and is successful in expanding into the UK,

2.  the theme parks gradually recover, and

3.  the movie business straightens itself out and starts to make money again.

It would be icing on the cake if the ABC television network/stations stabilized, and/or if–in a reversal of twenty-five years of avoidance–customers started to show up at EuroDisney.  But these operations are small enough that all they really need to do is not get in the way too much.

How did the quarter stack up?

1.  ESPN keeps chugging along.  Its ratings are the highest they’ve ever been.  Ad revenue is up modestly and advertising rates are beginning to recover.  During the December quarter, revenues for ESPN and the Disney Channels (strength overseas) were up 8% year on year.  Operating profits were only up 5%, the difference presumably being start-up spending for ESPN’s expansion in the UK.

2. Domestic parks and resorts were up a little, but overall operating results were down $7 million to $375 million because of weakness at Disneyland Paris.  Worldwide revenues were flat.  DIS is attempting to wean domestic customers off discounts, with what sounds like some success.

Trying to look deeper, you run into a messy tangle of countercurrents.  Briefly,

–attendance is up

–Disneyland attendance was up 9%, Disneyworld was up 15%

–on the other hand,New Year’s Day–worth an extra $50+ million in revenue–was in this year’s quarter but not in the year-ago period.  Adjusting for this, Disneyland attendance was +4%, Disneyworld 1%.  Look at the difference New Year’s makes!

–hotel occupancy and spending inside the parks are both down by around 4%.

DIS has changed its best discount hotel offer from buy four nights, get three free to buy five nights, get two free.  Reservations are down 10% year on year, presumably as a result.  Consumers are also doing what you’d expect.  They’re not making reservations until the last minute, knowing there are plenty of hotel rooms to go around.

Your guess is as good as mine about how this will turn out.  My conclusion:  at worst, we’re bouncing along the bottom in the theme parks business.  Maybe DIS is doing somewhat better than that.  DIS has always been good at extracting money from theme park customers’ wallets.  For now, I’m willing to trust to the company’s revenue optimization software.

3.  Studio entertainment’s operating income was up 30%, on flat revenue.  The use of project accounting makes this another headache-inducing area when you’re trying to figure out what’s going on.  DVD sales from Up and The Proposal were higher-profit (because they had bigger box office and lower production costs) than their year-ago counterparts WALL-E and The Chronicles of Narnia: Prince Caspian.

Theatrical distribution profits were lower year on year, because of “higher film cost writedowns.”  DIS presumably wrote down its film costs as aggressively as it could (basically, you can’t write costs off so much that you artificially create a profit for yourself in a subsequent period) in September.  So these further writedowns must mean diminished expectations for films currently/recently in the theaters.  There’s nothing much DIS can do about this.  Economically, the money was lost in production decisions made two years or more ago.

Interestingly, no one–neither management nor analysts–mentioned The Princess and the Frog. According to Box Office Mojo, the film has grossed $150 million worldwide to date, vs. production costs of $105 million.  Is this the writedown?

Minor ins and outs:

1.  DIS intends to buy back the 58.5 million shares it issued in the Marvel Entertainment acquisition.  That will likely increase yearly eps by 2% or so, offsetting part of the roughly 5% dilution caused by acquisition costs.

2.  DIS organizes its business on a weekly basis.  An “ordinary” DIS year is 52 weeks, or 364 days.  To keep it’s accounting year from getting too much out of line with the calendar year, the company periodically has 53 week years to adjust.  Last year was one of the 2% bigger years (this is also the reason January 1st fell in the “December” quarter).  So flat operating performance year to year would produce around 2% lower results.  Just a fact of life.

3.  National advertising spending by telcos and tech firms is up; locally, autos are, too.

4.  DIS is seeing strong blue-ray sales.  68% of purchases of the rereleased Snow White–admittedly released on blue-ray ahead of DVD–were blue-ray.  The company has also seen substantial demand of its blue-ray “three-pack” of Up–blue-ray + dvd + Keychest (DIS’s proprietary digital download format).

5. DIS was very enthusiastic about the iPad.  I’m sure it’s not just that Steve Jobs is, by virtue of the Pixar acquisition, such a big shareholder of DIS.   DIS appears to think, correctly in my opinion, that the iPad will be an excellent vehicle for delivering e-book and short film content for DIS to children.  Maybe iPads loaded with a DIS library will become a key gift from doting grandparents.

My conclusion: Nothing really out of the ordinary in the quarter.  For a year, I’ve been thinking that economic recovery in the US will be unusual for us, in that business will recover before the consumer (this is the normal pattern in the rest of the world).  This implies that one should have the patience to wait for the most economically sensitive part of DIS, the theme parks, to recover.

One can also hope that the movie business is healing itself.  Certainly, in addition to whatever Disney Studios may have, there’s enough talent in Pixar and Marvel.  If early buzz is to be trusted, Ironman 2 will be another blockbuster.

No reason to buy the stock immediately.  No reason to sell, either.

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