Friday, August 21, 2015

Recent Buy of Walt Disney

I’m so fortunate to be in a position where I’m able to fairly regularly put capital to work.
And I’m not just putting capital to work. I’m putting it to work by investing in some of the highest-quality businesses in the entire world. And not just any high-quality businesses. But only those that are so increasingly profitable year after year that they gush excess profit. So what to these businesses do with all of this extra cash? They send it to shareholders in the form of not just regular dividend payments, but regular dividend payments that are routinely increasing year in and year out.
It’s all in the name of turning cash into cash flow. And it’s this increasing passive cash flow that will one day fund my expenses, rendering me financially independent.
Again, I’m fortunate.
What happened recently is that I found myself with a little extra cash, which I used to load up my BB gun. I’m generally on the hunt every single day, looking for attractive prey.
Well, attractive prey became even more attractive after a significant drop recently. And so I took advantage of that by unloading a few BBs and bagging a solid catch.
I purchased 15 shares of Walt Disney Co. (DIS) on 8/5/15 for $110.52 per share.

Overview

Walt Disney Co., together with its subsidiaries, is a diversified global media conglomerate.
They operate through five segments: Media Networks (43% of fiscal year 2014 revenue); Parks and Resorts (31%); Studio Entertainment (15%); Consumer Products (8%); and Interactive (3%).
Disney owns a number of different, but complementary, businesses in media and entertainment. Perhaps most well known, they own and operate the Walt Disney World Resort in Florida and the Disneyland Resort in California. They also wholly own, have ownership interests, and/or collect royalties from a number of related parks, cruise lines, and resorts across the world.
But the company is much more than that. They have rather substantial assets in media broadcasting, including the ABC broadcast network and eight television stations. In addition, they own cable assets in ABC Family, Disney Channels, a 50% stake in A&E Television Networks, and an 80% stake in ESPN.
Studio entertainment includes live-action and animated motion pictures, direct-to-video content, musical recordings, and live stage plays. Distribution of this content is primarily through the Walt Disney Pictures, Pixar, Marvel, Touchstone, and LucasFilm brands.
Of course, they also work with publishers, licensees, and retailers throughout the world to manufacture, market, and license consumer goods based on their intellectual property.

Record Quarterly Profit… And The Stock Drops More Than 10%

analyzed Disney back in December. Not much has changed, so I won’t repeat myself. Instead, I’ll talk about recent results and activity.
Disney recently reported fiscal year 2015 Q3 results, and they were, well, outstanding. EPS was up 13% compared to Q3 2014 and revenue was up 5%.
But the stock plummeted immediately after results came out. In fact, over a two-day period, it was down well over 10% before bouncing back a little bit.
This appears to be a combination of two things.
Primarily, revenue was a bit below expectations. But more to the point, there was some concern over reported modest subscribers losses at flagship cable channel, ESPN.
Second, the stock was already a bit heavy on the valuation, and a pullback wasn’t really all that unreasonable.
However, I’m not really concerned about ESPN in the slightest. The company’s guidance for domestic cable affiliate revenue dropped to the high-single-digit range, which is still pretty appealing. But the company’s other segments remain robust, especially Studio Entertainment. So this might shrink cable’s influence on the company’s bottom line over time, which, in my view, wouldn’t totally be a bad thing. But, holistically, the company is still growing at a rather rapid clip.
Moreover, even while digital content is consumed in different ways as options and variety expand, the fact of the matter is that the vast majority of all sports programming is watched live. And ESPN is still the clear leader when it comes to sports programming. The company is, however, open to selling ESPN directly to the customer at some point down the road. Content consumption might continue to change, but I don’t think the actual value of that content/programming will change much over the foreseeable future. In addition, the company’s Media Networks segment is comprised of a lot more than just ESPN.
Meanwhile, the company has so many exciting projects going on.
Bob Iger discussed Shanghai Disneyland during the conference call, expecting the park to open spring 2016. It was also announced during Disney’s D23 Expo that two new Star Wars lands will open – one in Anaheim’s Disneyland and one in Orlando’s Walt Disney World. These will take a number of years to build, but it’s exciting to think about where this company will be in five years.
Of course, there is also a slate of new movies coming out that portend even more tie-ins down the road. Star Wars: The Force Awakens will be released in December, the first in what will be a new trilogy. A sequel to Frozen has already been announced. And the Marvel universe keeps pumping out hit after hit.
This is just a media and entertainment juggernaut that is mostly firing on all cylinders right now. It’s by far my favorite entertainment/media company in the entire world.
One other quick note is that the company recently surprised investors by abolishing their annual dividend in favor of a semi-annual dividend. On top of that, they increased their dividend by 14.8%… just six months after increasing the dividend by 33.8%.

Risks

Disney’s risks include broader economic slowdowns, which could limit demand for their theme parks, cruise ships, and resorts.
In addition, cable subscription cancellations would reduce demand for and the fees driven from their cable networks. Costs for programming, if not managed properly, could unfavorably impact profit.
They also have to constantly be able to adapt their content to current consumer demand and interest. Content, especially in regards to big-budget films, can be risky in the sense that the demand has to be there to drive profit.
And as a global company, they face currency risks.

Valuation

As I noted earlier, I think part of the reason the stock retreated so aggressively and so quickly after Q3 results was because the stock wasn’t cheap, and any whisper of weakness sent short-sighted investors scurrying. Still not overly cheap after the drop, but I’m willing to pay up for quality here.
The stock trades hands for a P/E ratio of 22.93. This isn’t far off from what the stock was sitting at back in December 2014 when I initiated my position, even though the price has advanced somewhat considerably since. Profit is up quite a bit as well over that time frame, so there you go. I will note, however, that this is well above the five-year average P/E ratio of 18.2 for this stock. But I think that’s more a function of DIS being probably a little too cheap back then rather than a case of it being extraordinarily expensive right now. In addition, the company has transformed quite a bit over just the last five years, leading me to believe that the higher multiple is warranted.
I valued shares using a dividend discount model analysis with a 10% discount rate and a two-stage growth rate: 20% dividend growth for years 1-10 and a 7% terminal growth rate. I used a two-stage model due to DIS’s low yield. The growth rates I used appear to be reasonable to me based on Disney’s historical results, low payout ratio, and penchant for rewarding shareholders with generous dividend increases now that the financial crisis is behind us. The DDM analysis gives me a fair value of $134.36.

Conclusion

This purchase doubled my position in Disney, and I’m really happy about that. The yield isn’t great at 1.2%, so I have to be careful in regards to how much capital I put to work here.
But this remains one of my favorite business models out there. Its customers are extremely loyal, the cross-promotion and tie-ins are unlike anything else out there, and there’s still so much potential for profit and growth moving forward. If I had to bet all my money on Disney being able to grow its dividend at an attractive rate for the next 10 years, that’s a bet I’d feel pretty comfortable making. If the yield were higher (implying a higher payout ratio), I’d want to be even more aggressive here.
As it sits, I’m very happy with this position. But I would absolutely be open to increasing it once more if the price drops closer to $100 over the short term.
This purchase adds $19.80 to my annual dividend income, based on the current $0.66 semi-annual dividend.
I’m going to include a couple of other valuation opinions below, as I use these to concentrate my reasonable valuation estimate:
Morningstar rates DIS as a 4/5 star valuation, with a fair value estimate of $134.00.
S&P Capital IQ rates DIS as a 4/5 star “buy”, with a fair value calculation of $109.10.
I’ll update my Freedom Fund in early September to reflect this recent purchase.
Full Disclosure: Long DIS.
What’s your opinion on Disney? Think it’s a great business? Why or why not? 
Thanks for reading.

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