Why the 2017 Disney Bull-Bear Case May Have Low Bar for Expectations

January 5, 2017 by Jon C. Ogg

Walt Disney Co. (NYSE: DIS) managed to return just 0.67% for shareholders in 2016, with a $104.22 closing price on the last day in December. Its paltry dividend yield accounted for most of that gain, but what saved the year for Disney was a rather strong fourth quarter. It turns out that a stronger consumer and an expected lower corporate tax rate in the post-election policies are being viewed quite positively by shareholders again.

The $104.22 year-end price compared with a $108.48 consensus analyst target price from Thomson Reuters, so investors could imply an expected upside of 4.1%. Then there is the 1.5% dividend yield to consider, after it was raised in 2016, for a potential total return of close to 5.6% expected in 2017, if the analysts are correct.

Disney’s 2015 total return for shareholders was 12.9%, including its dividend adjustments. When 2016 was getting started, and when the Star Wars hype from “The Force Awakens” was so strong with the force, the consensus analyst price target was $118.24 back then. Now, a year later, that target is close to $10 lower, which might make for a feeling that the bar of expectations could be quite low.

24/7 Wall St. has evaluated many bullish and bearish scenarios for the Dow Jones Industrial Average components in 2017. There are a lot of things going in Disney’s favor, even if there has been a huge drag from ESPN losses on cord cutters. ESPN lost a half-million subscribers in October alone, and there are fears that cord-cutting trends will only continue in the year or years ahead. What if analysts and investors were just too focused on ESPN? Or what if cord cutters just do not keep following the rapid trends? Deutsche Bank even in November noted that the ESPN subscriber declines have improved and should improve further.

When Disney reported earnings in late 2016, it was not, on the surface, the world’s greatest report, even if shares did manage to rally. The company had $1.10 in earnings per share (EPS) and $13.14 billion in revenue, while consensus estimates from Thomson Reuters had called for $1.16 in EPS and revenue of $13.52 billion. The same period in 2015 reportedly had EPS of $1.20 and $13.51 billion in revenue.

In terms of its business segments, Disney reported that its Media Networks had revenues decrease 3% to $5.66 billion, with $1.67 billion in operating income, down 8%. The Parks and Resorts reported $4.39 billion in revenue, up 1%, but the $699 million in operating income was down 5%. Studio Entertainment had revenues increase 2% to $1.81 billion, but operating income fell 28% to $381 million. Disney’s Consumer Products & Interactive Media unit reported revenues were down 17% to $1.29 billion, as well as $424 million in operating income, down 5%.

One of the big wild cards has been the beloved Star Wars franchise that was purchased for $4 billion. Unless real aliens start arriving on earth, this science fiction universe has literally endless life ahead, and Disney is the one company that can capitalize on Star Wars more than any other company. Proof: a Star Wars theme park! Also, more spin-off films are coming down the pipe too (a Han Solo one included).

Walt Disney shares were added to Merrill Lynch’s US 1 list on December 19, 2016. Despite admitting the ESPN woes, the movie franchises, Trump tax plans, buybacks and parks traffic let Merrill Lynch maintain a Buy rating and $125 price target.

On December 31, 2016, S&P reiterated its Buy rating and $110 price target on Disney. After an interstellar opening weekend for the Star Wars feature “Rogue One,” JPMorgan reiterated its Overweight rating and it named Disney as one of its top picks for 2017. The firm said:

We believe this impressive opening weekend performance of the first spin-off film in the Star Wars universe solidifies it as a major franchise for Disney with great longevity that is also likely to translate into solid near-term Consumer Products sales and longer-term greater attendance and per-cap spend at the two Star Wars Lands at Disney World and Disneyland currently being built that we expect to open in 2019 at the earliest. We remain positive on Disney as one of our top picks for 2017, as the success of the company’s films and franchises continue the company’s multi-year, cross-divisional, hugely profitable strategy that should lead to outsized growth compared to peers.

As this is a bullish and bearish analysis, 24/7 Wall St. wanted to feature one of the more cautious analyst calls made in recent weeks too. Cowen maintained a mere Market Perform rating in early December, but its meager $90 price target shows that not everyone is a believer here. Cowen’s report even said that the recently renewed enthusiasm for the name may be a bit premature, and the firm addressed the Iger CEO succession not being in place now:

While this narrative is interesting, a lot rides on what happens in the film segment, and we remain concerned both about overall industry dynamics and the risk that Disney’s film performance reverts towards the mean. We also think that projecting the health of the cable ecosystem out into 2018 remains tricky, especially given the potential for virtual bundles to be a disruptor (granted, positive or negative) over the next year. Finally, CEO Bob Iger still does not have a clear successor, which introduces another potential risk factor.

Other things are going well for the movies unit too. It turns out that half of the 2016 top grossing films were based on comic book characters or adaptations. Disney has Pixar and Marvel, on top of its traditional Disney franchise films. Its movie library is endless, with many films and characters going back long before all of us were alive. There are also said to be hundreds of characters that were in various development stages for future film and franchise releases for films and all that follows.

Disney’s theme parks business, particularly with a strong launch in Shanghai China, may be close to immune from economic woes. Families were going to the Disney parks before, during and after the recession. Even rival numbers from Universal theme parks are still showing strength.

Maybe it takes being a parent and loving film and entertainment to really be attached to Disney these days. If you are a parent, there is probably a 90% chance that at least one of your kids is hooked on one or more of Disney’s characters. Even adults (older and younger) have brand loyalty to some of the characters.

For years it has been the case that Disney was an expensive stock for investors. Now its stock woes of 2016 may have changed that. Disney’s growth has been steady and is expected to remain steady. The $42 billion in revenues from 2012 were over $55 billion in 2016 and are expected to rise to $66 billion by 2020. Disney now trades at 18 times current earnings, but that is compared to just 16 times expected 2018’s anticipated earnings and 14 times expected earnings in 2020.

Disney also has room to improve on its dividend. Its semiannual dividend was hiked at the end of 2016 and went from $0.71 to $0.78 per share. If Disney is earning close to $6.00 per share in 2017, then it is paying just 25% or so of its earnings out to shareholders before considering stock buybacks. The dividend yield of 1.5%, which is ranked as the fourth worst yield among the 30 Dow stocks. Disney could do much better on its dividend if it chooses to do so when it gets a new CEO in 2018.

Disney shares have a 52-week trading range of $86.25 to $106.75, and the market cap currently is $166 billion.

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