Walt Disney Co.: Buy Trade – Position Open July 24, 2017

Description

The Walt Disney Company (NYSE:DIS) is an entertainment company. The Company operates in four business segments: Media Networks, Park and Resorts, Studio Entertainment and Consumer Products & Interactive Media. The Media Networks segment includes cable and broadcast television networks, television production and distribution operations, television and radio stations. Under the Parks and Resorts segment, the company designs and develops new theme park concepts and attractions and resort properties. The Studio Entertainment segment products and acquires live-action and animated motion pictures, direct to video content, musical recordings and live stage plays. It also develops and publishes games, books, magazines and comic books.

Source: Thomson Reuters

Investment Rationale

DIS has the best content portfolio in the industry. The company owns Walt Disney Studios, Pixar Animation Studios, Marvel Studios and Lucasfilm Ltd. Collectively; these studios have been dominating box offices around the world and DIS has many upcoming movies set to continue that domination. Revenue generation from content does not stop at box office sales for DIS, with merchandising, theme parks etc. also contributing to the company’s bottom line. As the company continues to own rights to some of the most valuable intellectual properties (IPs), we believe that DIS remains well positioned to continue reaping the benefits from being the king of content. Along with its strong balance sheet and strong cash flows, we are bullish on DIS and believe that DIS is attractively valued at current price

Recent Price Action: Since its previous earnings results in May, the company has been on a down trend, falling from about its 52-week high of USD 116.10 to about its YTD low of USD 103.30. Recently, DIS has shown signs of rallying and closed about 3.75% up to USD 107.09.

Upcoming Blockbusters: DIS has been firing on all cylinders when it comes to the production of content. In 2016, of the top 10 highest worldwide grossing films, DIS produced 5 of them (with all 5 being the top 5): Captain America: Civil War, Rogue One: A Star Wars Story, Finding Dory, Zootopia, and The Jungle Book. Collectively, DIS claimed an estimated 26.3% Market Share of box office sales. YTD in 2017, DIS has 3 movies in the top 10 Worldwide grossing films; Beauty and the Beast, Guardians of the Galaxy Vol 2 and Pirates of the Caribbean: Dead men tell no tales. With half the year to go, DIS still has several highly anticipated films to be released this year. Star Wars: The Last Jedi, the sequel to 2015’s huge success, Star Wars: The Force Awakens, which is the 3rd highest grossing film of all time, is set to release in Dec 2017. Thor: Ragnarok, which is set in the Marvel Cinematic Universe (which as a franchise has earned nearly USD 3.8 bn in 2016, almost USD 1.5 bn more than the Harry Potter series), will release in Nov 2017 and finally a short film set in DIS’s bestselling Frozen, Olaf’s Frozen Adventure, which will release in theaters along with Pixar’s new film Coco in Nov 2017.

DIS reported USD 2.70 bn in operation income from their Studio Entertainment segment in 2016, up 37% YoY. As mentioned above, content revenue contribution does not stop at the box office for DIS. By capturing the imagination of consumers in theaters, DIS is able to translate that to sales of consumer goods and theme park attendance. Of note, Star Wars: Galaxy’s Edge, which is set to open in 2019, is a prime example of DIS monetizing their IPs past the box office stage. DIS earned USD 3.30 bn operating income on USD 16.97 bn in revenue from their Parks and Resort segment.

Direct to Consumer (DTC) streaming:  ESPN, a key contributor to DIS revenues, has of late been a thorn in the side of DIS. With falling subscription numbers and lower cable viewership numbers, ESPN numbers has been the bane of DIS’s earnings results, with the market focusing on its recent poor performance. However, we believe that the concerns related to ESPN, while valid, might be overblown. The company has invested in BAMtech, with plans to launch a collaboration stream a multi sports subscription service. While the available content is not the full ESPN content, we believe that this represents a valid channel that DIS can distribute content to consumers should the fall in subscription numbers accelerate.

Besides sports offerings, as mentioned earlier, there is very high demand for DIS content, and we believe that there will be many lucrative deals with streaming services, such as Netflix or Amazon Prime, to have DIS content on their platform. As such, we believe that market concerns about falling cable subscription numbers are overblown.

Valuations:  DIS’s closed at USD 107.09. It trades at a PER of 18.67, slightly below its 5 year average of 19.77. It has an Operating Margin of 25.74% and a Net Profit margin of 13.35%. Compared to its peers, Twenty-First century Fox Inc trades at a 16.94, Time Warner trades at a PER of 18.80. While DIS trades a PER that is comparable to its peers, given how dominating DIS’s content portfolio is and the potential for growth from it, we believe that DIS should trade at a premium compared to its peers. DIS pays a div of USD 1.56, representing a yield of about 1.46%, with a payout ratio of 26.4%. DIS has an Interest Coverage Ratio of 32.61 and Free Cash Flows of USD 8.44 bn in 2016. Our Target Price of USD 116.00 is set based on Technicals.

Technicals: DIS has been trending up steadily since October 2016 after the 90.00 psychological support area kept a floor on price. The uptrend continued until April 2017 where price experienced a correction of approximately 11%.

DIS weekly chart

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Red line = 20 period moving average, blue line = 60 period moving average, Green line  = 200 period moving average

Source:  Bloomberg, PSR

Nonetheless, the long term uptrend remains intact as price continues to be supported off the confluence of 50% Fibonacci retracement level and 60 week moving average. The rebound off the 102.72 seems to be forming the next higher low point within the uptrend.

Zooming into the daily time frame suggests the bullish narrative is returning shown by the recent bullish break above the downtrend line on 20 July 2017. Moreover, price has also succeeded in closing above the 20 and 60 day moving average signals an acceleration in the bullish momentum.

DIS daily chart

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Support 1: 102.72                                                Resistance 1: 112.00

Support 2: 100.79                                                Resistance 2: 116.00

Red line = 20 period moving average, blue line = 60 period moving average,  Green line  = 200 period moving average

Source:  Bloomberg, PSR

Expect the uptrend to resume next for price to retest the 116.00 resistance area followed by 120.00.

Conclusion: We are bullish on DIS due to 1) its dominant content portfolio and upcoming blockbusters, 2) its transition to streaming and 3) its strong balance sheet and valuation. As such, we reiterate our belief that the stock was oversold after its earnings and with recent signs of recovery, we are bullish.

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