Source: Disney.
Disney (DIS 1.60%) stock has done remarkably well over the long term, the House of Mouse is up by over 190% through the last five years. On the other hand, Disney is on a pullback lately, down by nearly 18% from its highs of 2015 due to a weak market environment and a disappointing earnings result for the last quarter. When a fundamentally solid business offers an attractive entry point, that's typically a buying opportunity for long term investors, so it sounds like now is the right time to take a look at Disney.
The reasons behind the decline
Stock markets around the world have been notoriously weak and volatile due to concerns over the worrying economic news coming from China over the last several weeks, and Disney is not immune to general market conditions. In addition, investors reacted with negativity to the company's earnings report for the last quarter.
Disney delivered healthy financial performance for the quarter ended in June, sales grew 5% year over year to $13.1 billion, while earnings per share increased 13% versus the same quarter in 2014. Earnings were actually ahead of Wall Street analysts' forecasts, however, the devil is usually in the details. The media networks division was below expectations during the quarter, and this is an important factor since the segment brings in nearly half of Disney's total revenue.
ABC ratings remain quite sluggish lately, but that was broadly expected by analysts. On the other hand, Disney reported a "modest" sequential decline in ESPN subscribers, which turned out to be a big reason for concern. Many consumers are moving away from traditional cable, cord-cutting is a major trend across the entertainment industry, and it's now even hurting the leading sports network in the world.
The business is still rock-solid
ESPN is a remarkably important asset for Disney, so a decline in subscriptions is bad news for the company, even if it's a small one. On the other hand, everything indicates that ESPN is in a position of strength to adapt and continue thriving under the cord-cutting revolution. The network is the undisputed leader in sports media, according to management 83% of all multi-channel household turned to ESPN at some point during the first quarter of 2015. Also, 96% of all sports programming is watched live, and this is a big differentiator when it comes to advertising value and the potential impact of streaming technologies.
Besides, Disney's other business segments are doing remarkably well. The studio division delivered a 15% increase in segment operating income during the last quarter on the back of strong performance from Avengers-Age of Ultron, Cinderella, and Inside Out. Both attendance and average spending at the company's parks in the U.S. are on the rise, and operating income in this division grew 9% during the period. Operating income in consumer products jumped by a vigorous 27% due to strong sales of Frozen, Avengers, and Star Wars products.
And the best might be yet to come. Disney will launch the new Star Wars movie, The Force Awakens, in December. Needless to say, this promises to be a major blockbuster driving massive sales for the studio division. Management has already confirmed that it's working on additional movies to fully capitalize on the Star Wars franchise over the coming years, so Star Wars is about much more than a single movie for Disney.
In spring of 2016 Disney is planning to inaugurate its first theme park in Mainland China, Shanghai Disney. This will be one of Disney's biggest projects ever, featuring six themed resorts, two hotels, a shopping, dining and entertainment district, and a park. Considering the magnitude of the project and the popularity of Disney's brands and intellectual properties in China, this could open the door to exciting growth opportunities for the company.
In a nutshell, ESPN is strong enough to adapt to the cord-cutting revolution, and the other business segments are stronger than ever. With this in mind, Disney looks poised to continue delivering solid performance for years to come.
Fair valuation
Disney stock typically trades at a substantial premium versus the overall market. This is quite understandable when considering the company's quality, its amazing track record of success over the years, and its promising potential over the middle term. However, after the recent decline, Disney stock is trading at valuation levels that are roughly in line with the broad indexes, and this looks like an attractive entry point for investors.
At current prices, Disney is trading at a P/E ratio around 21 times earnings over the last year, a moderate premium over the S&P 500 index and its average P/E ratio in the neighborhood of 19. When looking at forward estimates, Disney trades at a forward P/E of 18 times earnings forecasts for the coming year, in line with the S&P 500.
Buying a top quality company for an average valuation is generally a good recipe for superior returns over the long term, so Disney stock looks like a compelling purchase right now.
