Disney Poised to Rebound From August Sell-Off

October 14, 2015 Printer Friendly Printer Friendly

Disney (DIS) shares dropped precipitously in August after CFO Christine McCarthy revealed over a conference call that the company expected a 1% decline in ESPN subscriptions in 2016. The ensuing sell-off was overdone and has created a buying opportunity for those wanting to either invest or increase their position in Disney. Below is Disney’s performance over the last twelve months, plotted above the Relative Strength Index of the stock.
disney rsi

Share price has been increasing gradually the last six months, with the more recent upward trend reflecting expectations for release of Star Wars: The Force Awakens, which comes out December 18th. Investor sentiment for most of the summer was positive, and Disney shares have been overbought (RSI >70) since mid-June. When management revealed sub-loss on August 4th, the resulting sell-off was overdone, with the RSI falling to 30. RSI has gradually climbed back to around 50, but far below the average value that the stock has traded at the past 12 months.

Currently, Disney is not in its usual overbought or near-overbought position. But does that mean that it is a good buy? First let’s look at Disney’s performance against the Diversified Media Industry:
disney valuation

Disney has outperformed the Media industry by wide margins for the last five years, more than doubling the industry and S&P return. Disney also boasts better margins: both Operating and Net Margins are nearly 50% higher than that of the industry. Despite missing Q2 revenue projections of $13.2 billion (they recorded $13.1 billion), Disney still saw profits rise 11% to a record $2.48 billion. Sure, Disney trades at a P/E significantly higher than their industry, but this is not news to them. Their shares have only traded at a P/E lower than 20 for a total of 4 days in the last twelve months (shown below). It is likely that Disney will at least maintain, if not exceed, their P/E ratio in the near future. If EPS projections (also shown below) are taken into consideration, holding P/E constant, the stock’s price could rise as much as 12% by the end of 2015.
disney price earnings

disney analyst estimates

So where is the anticipated EPS growth coming from? Well, Disney is about to see their first returns on their $4.05 billion acquisition of LucasFilm in 2012. Disney has successfully monetized two studio acquisitions under CEO Robert Iger: $7.4 billion Pixar in 2006 and $4 billion Marvel in 2009. Both studios have reeled out commercially and critically successful movies since being bought by Disney, and the company should have similar expectations for LucasFilm. Disney already has announced plans to release five Star Wars movies out of LucasFilm by 2020: a trilogy focused on the main Star Wars storyline, and two spinoff movies.

The first of these movies, Star Wars Episode VII: The Force Awakens, comes out on December 18th, and should fuel Disney’s fourth quarter earnings. Star Wars movies are historically box office studs – four of six Star Wars movies have been the top performer at the box office in their respective years, with the other two occupying the second and fourth spots. Most analysts are predicting between $1.5 billion and $2 billion for worldwide gross for the movie, with some analysts predicting as high as a $2.2 billion box.

Star Wars merchandise will also play a key role in Disney’s expected earnings increase – some analysts are predicting as much as $5 billion in merchandising sales in 2016, of which Disney would collect roughly $500 million in licensing. Disney should expect an additional $1.3 to $1.8 billion in sales of Star Wars home entertainment for the movie. This doesn’t mention the added value of having Star Wars themed attractions in their parks and resorts sector, including Shanghai Disneyland (opening in 2016), which should contribute to revenue growth as well.

Over the course of five movies between now and 2020, Disney should see tens of billions of dollars in revenue from the Star Wars franchise. The franchise’s performance should fit in well with Disney’s hugely successful Marvel and Pixar franchises. The Marvel studio is set to release nine movies between now and 2019, and Pixar has announced four movies through 2017. These franchises posted a combined $4.5 billion in theatrical and home distribution revenues in 2014, and show no sign of slowing down. Disney’s Studio Entertainment segment should drive earnings growth in the fourth quarter of 2015 and in the next few years.

To take a fair look at Disney’s valuation, we need to address why the company’s share price has fallen so sharply. The dominating factor in Disney’s tumble was the projection of ESPN subscription decline, which is expected to fall 1% next year. Media Networks accounted for 43% of Disney’s revenues in 2014, with ESPN attributing the lion’s share of that. So when it was announced that Disney’s biggest revenue driver was declining, there was rightfully some adjustment of the stock price. But the reaction to this news was overblown. While ESPN subscriptions may have declined, their affiliate fee has not. In 2014, the affiliate fee (what cable providers pay the network to air their channels) rose 8%. So while revenue growth in the Media Networks may be slowed due to a subscription decline, revenue in that business sector is still projected to grow. Also, it’s not as if this subscription decline affects ESPN alone – most networks are seeing the same decline given the trend of cord cutting. And as cord cutting increases, there is no reason to believe that ESPN won’t be able to deliver their content in another format. ESPN owns rights to the NFL, NBA, MLB, NASCAR, and College Football, and has established online platforms ESPN.com and WatchESPN on which to deliver these programs. The sell-off over the ESPN subscription loss has been far overblown.


The ESPN subscription loss that led to a decrease in Disney’s stock price has been overblown. The sell-off was overdone and has created a buying opportunity. Strong performance from Disney’s Studio Entertainment sector should see revenues rise in the near future. Investors looking to get a position in DIS would do well to buy soon.