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The Walt Disney Company (DIS) - Thesis

The Walt Disney Company (DIS)
Rating: BUY
Current Price: $101.57
Price Target: $115

The Walt Disney Company (DIS) is a behemoth of valued brands, with lots of cash flows, strong earning power, a decent dividend, and it’s currently on sale.  We value DIS at $115 per share using a 50/50 combination of a discounted cash flow model and a valuation formula first published by Benjamin Graham, Warren Buffett’s mentor, in the 1940’s.  Disney’s stock price declined in August after missing Wall Street revenue estimates, and then it never recovered as market-wide declines kept the stock price down.  Relative to its current market price, we believe Disney has significantly more upside than the overall stock market.  We rate Disney a buy, and we own the stock.

Disney divides itself into five business segments: (1) media networks, (2) parks and resorts, (3) studio entertainment, (4) consumer products and (5) interactive media. Media Networks comprise an array of broadcast, cable, radio, publishing and digital businesses across two divisions – the Disney/ABC Television Group and ESPN Inc. Walt Disney Parks and Resorts (WDP&R) is a provider of family travel and leisure experiences. The Walt Disney Studio brings movies, music and stage plays to consumers throughout the world. Disney Consumer Products (DCP) delivers product experiences across thousands of categories from toys and apparel to books and fine art. Disney Interactive is a creator of interactive entertainment across all current and emerging digital media platforms.

“Media Networks” (Disney/ABC television and ESPN) contributes the most revenue and operating income, but the company generates growth across its diversified business segments as shown in the following segment results tables:

In addition to the past performance provided in the tables above, Disney management provides forward guidance indicating strong expected future growth.  For example, along with its third quarter earnings release, the company stated that it should see mid-single digit growth in fiscal year 2016 due to the strengthening of dollar and modest subscriber losses at its cable networks.

Additionally, Disney expects its upcoming release of the movie “Star Wars: The Force Awakens” to generate significant growth for the company.  Another source of significant growth is expected to come from Disney’s Shanghai theme park resort which is expected to be operational by Spring 2016.

A quick discounting of Disney’s free cash flow suggests the company is trading at an attractive price.  Calculating free cash flow as cash flow from operations ($9.8 billion) minus capital expenditures ($3.3 billion), and then discounting this by the company’s weighted average cost of capital (~8.3%), and assuming it can grow at 7.5% per year for the next 5 years, followed by 3.0% per year thereafter, gives us a present value of ~$198 billion, which is more than 15% upside versus its current market cap of $172 billion.  Considering Disney has 1.69 billon shares outstanding, this gives us a valuation of $117 per share.

As a second estimate of Disney’s valuation, we use a formula first published by Benjamin Graham (Warren Buffett’s mentor) in the 1940’s (EPS x (8.5 + 2 x growth)).  We assume earnings will grow by 14.0% for the next five years (this is the average 5-year earnings growth estimate, per year, by the 32 analysts surveyed on Yahoo Finance), and then we assume earnings will grow by 3% per year thereafter.  This gives us a valuation of $112 per share which is about 11% upside versus the current share price.  Importantly, this is a conservative estimate because if Disney is able to grow faster than 3% after five years, then the company is worth more than this valuation suggests.

Perhaps the biggest risk to Disney is anything that could damage its strong brand reputation.  According to Forbes, Disney is the 11th most valuable brand in the world.   Related to Disney’s brand, the company notes the following risk in their annual report: “Changes in public and consumer tastes and preferences for entertainment and consumer products could reduce demand for our entertainment offerings and products and adversely affect the profitability of any of our businesses.”  Further, Disney notes: “The success of our businesses is highly dependent on the existence and maintenance of intellectual property rights in the entertainment products and services we create.”

Another significant risk noted by Disney is simply that “changes in U.S., global, or regional economic conditions could have an adverse effect on the profitability of some or all of our businesses.”  Certainly a global economic downturn could adversely affect Disney as the company’s products aren’t a bare necessity, and could suffer from a reduction in consumer spending.

Another risk noted by Disney is that “changes in our business strategy or restructuring of our businesses may increase our costs or otherwise affect the profitability of our businesses.”  Certainly, Disney is a large company, with multiple business segments and lots of moving parts.  Any missteps in any part of the company could affect the organization as whole.

Disney’s stock price is cheap right now relative to its value, and this likely won’t be the case for long.  With great earnings power, strong cash flows, a decent dividend, and growth potential from the likes of the new Star Wars movie and the new Shanghai theme park, Disney is an outstanding blue chip stock to own for the long-term.

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