DIS 3Q12 earnings–highest all-time profits

the report

On August 7th, DIS released profit results for 3Q12 (the DIS fiscal year ends in September).  The company posted its highest quarterly profits ever–$1.83 billion.  At $11.1 billion, revenues were up 4% year on year for the period.  EPS were $1.01.  That was 29% from the $.78 posted for 3Q11.  It also compares favorably with the Wall Street consensus estimate of $.93/share.

The stock initially broke through the $50 barrier on the upside on the news.  It has since settled back a bit below that mark.

the details

media networks

This segment makes up 2/3 of DIS’s operating income.  It’s mostly cable; and of that, the lion’s share of profits come from ESPN.

Operating income was flat, yoy, at $2.13 billion.  But a change in contract terms with Comcast has shifted into 1Q and 2Q $139 million in payments normally recognized in 3Q.  There are other underlying complicating factors (the norm for this segment, and for DIS overall) as well.  On an apples-to-apples basis, op income for Media Networks is probably growing at 10%+.

parks and resorts

This segment represents a bit less than 20% of DIS’s op income.

Parks and Resorts were up 21% yoy during 3Q12, at $630 million.  The comparison is flattered, however, by higher yoy royalty payments from Tokyo Disneyland, based on a rebound in attendance from the earthquake/nuclear disaster-depressed 3Q11.  DIS also received in the current quarter an insurance settlement for business interruption at Tokyo Disneyland last year.

Business is recovering strongly at DIS’s domestic theme parks–thanks in part to the successful makeover of the California Adventure park at Disneyland.  The company has new cruise ships and bookings are perking up as well.

Normalized growth for Parks and Resorts is probably closer to 10%.

studio entertainment

Movie results were up over 6x to $313 billion, thanks to the Avengers film, which has taken close to $1.5 billion worldwide.  Even so, films now represent less than 10% of DIS’s overall operating income.  Of course, successful movies can also have positive rub-off effects on the theme parks.  They’re the foundation of much of DIS’s merchandise sales, as well.

consumer products

To some degree, Consumer Products earnings are affected by internal negotiations about revenue sharing among segments about sales of character-related merchandise.  That was a yoy positive in 3Q12, when this segment posted op income of $209 million on sales of $742 million.  Growing at maybe 10% yoy, Consumer Products represents considerably less than 10% of DIS.

interactive

DIS’s gaming and internet businesses continue to make losses.  The good news is that interactive is gradually approaching breakeven.  The segment lost $42 million in the current quarter, less than half the deficit in the year-ago period.

a shift in international strategy at ESPN

For the past couple of years, DIS has spoken enthusiastically about international expansion possibilities for ESPN.  Its initial foray was to be soccer broadcasting in the UK.  the company’s tone was somewhat less positive a quarter ago.

During Q&A after the 3Q12 earnings announcement (you can get transcripts for free from Seeking Alpha–a really very valuable service), DIS management said in effect that it is reining in its European expansion plans after losing in the bidding for Premier League broadcasting rights.  It has also ended its Asian jv with News Corp.  ESPN is now concentrating on expansion in Latin America.

It’s too simplistic to characterize the UK expansion attempt as a mistake.  Rather, incumbents there (correctly, in my view) recognized the threat that ESPN posed and were willing to take substantial near-term losses in order to deny a powerful new competitor a foothold in their market.  Not pleasant for them, but the correct strategic move.

As for ESPN, this removes the near-term possibility of large positive earnings surprise from a new profit source.  But the immense popularity of its sports programming in the US make it a steady grower at 15% or so for the foreseeable future.

theme park cap ex is peaking

Other than for its theme parks, DIS isn’t in very capital-intensive businesses.  Of its total segment capital expenditure of $2.5 billion so far in fiscal 2012, $2.3 billion is attributable to expansion at Disneyland and Disneyland Paris, as well as construction of Shanghai Disney.  With Disneyland expenditure finished, the company is beginning work on overhauling Fantasyland in Disney World.  Despite this expense, company cap ex will likely gradually decline from the current level, providing higher free cash flow for dividend increases and further stock buybacks.

buybacks continue

Year to date, DIS has repurchased 55 million shares of its stock at an average price of a bit over $38 each.  During 3Q12, the buyback pace slowed somewhat, with 8.6 million shares bought at an average price of $43.37.

In its earnings conference call, however, DIS made it very clear that it regards its intrinsic value as significantly higher than the current share price–and that, therefore, buybacks will continue.  It intends to devote about a third of its free cash flow to a combination of buybacks and dividend increases.

my take on the stock

Accounting quirks aside, DIS seems to me capable of delivering 15% annual earnings growth, with limited cyclicality.  The stock is trading at a slight premium to the S&P 500.  It has strong management and a collection of iconic brands, the most important of which is ESPN.  My guess is it will be a mild outperformer over the year ahead.

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