Walt Disney Caps Off a Magical Year With a Tepid Quarter on Tough Comparables

Image source: Disney.

Walt Disney (DIS -0.45%) reported its fourth-quarter and full-year fiscal 2016 results after the market closed on Thursday. The entertainment giant's revenue edged down 3% year over year, while adjusted earnings per share declined 8%. Earnings on a generally accepted accounting principles (GAAP) basis increased 16%. Year-over-year results were significantly negatively impacted by tough comparables stemming from last year's quarter having an extra week compared to the current quarter, as well as certain businesses performing particularly well in the year-ago period.

Shares of Disney have been trading up mostly in the 2% to 3% range on Friday. This rise can probably largely be attributed to CEO Bob Iger's discussion on the analyst conference call about why he remains bullish on ESPN. The leading sports cable network, which is a cash cow for the company, has been at the center of the market's jitters about cable cord-cutting for about 15 months.

Disney's key quarterly numbers 

YOY = year over year. GAAP = generally accepted accounting principles. Data source: Disney.

While the quarterly numbers were tepid -- except for the continued powerful cash flow -- the quarter capped off a great fiscal 2016 for the House of Mouse:

• Revenue increased 6% to $55.63 billion.
• Segment operating income increased 7% to $15.72 billion.
• Net income grew 12% to $9.39 billion.
• GAAP EPS increased 17% to $5.73.
• Adjusted EPS rose 11% to $5.72.
• Cash provided by operations soared 21%.
• Free cash flow skyrocketed 27%.

It's key for investors to note that results for the fourth quarter and full year of fiscal 2015 include one additional week of operations compared to the current-year periods. Disney estimated the EPS impact of the additional week of operations is approximately $0.13 for the prior-year periods, which means that adjusted EPS grew on a comparable basis in the fourth quarter. The majority of the "fiscal period impact" was in cable networks, followed by parks and resorts and, to a lesser extent, the consumer products business. 

Disney doesn't provide specific guidance. To provide some context -- though long-term investors shouldn't give too much credence to Wall Street's near-term estimates -- analysts were looking for adjusted EPS of $1.16 on revenue of $13.52 billion in the quarter. So, Disney fell short of both expectations.

Here's how the four segments performed.

Media networks: ESPN hurts results

Data source: Disney.

Within the segment, cable networks revenue declined 7%, while broadcasting revenue increased 8%. Operating income in cable networks declined 13% to $1.45 billion, while it jumped 37% in broadcasting.

Homing in on the cable business: Operating income declined due to decreases at ESPN and the Disney Channels, partially offset by an increase at Freeform. The decrease at ESPN was driven by lower advertising and affiliate revenue and higher programming and production costs. The lower affiliate revenue was due to the fiscal period impact, and a decline of subscribers, partially offset by contractual rate increases.

As to the decline in ESPN's subscribers, ratings tracker Nielsen recently reported that the sports cable network lost 621,000 subs last month, a huge count that Disney disputed -- and still disputes, according to Iger's comments on the call. Iger said that this number is inconsistent with much more moderated trends observed by other respected third-party analysts and also noted that Nielsen's numbers don't count mobile subs. (Disney's been having success getting ESPN included in various distributors' over-the-top "skinny" streaming offerings, where there's likely a good chunk of mobile viewing.)

In addition to skinny packages, Disney's recently acquired 33% stake in video streaming leader BAMTech provides it with another new avenue for distributing its top-notch content.

Shanghai Disneyland. Image source: Disney.

Parks and resorts: Solid domestic growth continues, Shanghai Disneyland outperforming expectations 

Data source: Disney.

Disney's second-largest segment continues to be a steady performer thanks to continued strength in its domestic operations. Its overall performance was considerably better than these numbers reflect due to the fiscal period impact. Disneyland Paris remains a particular drag on performance in the international business, which was helped by Shanghai Disneyland's early strong performance.

Growth in the domestic operations was primarily due to growth at Disney World, partially offset by a decrease at Disneyland. The improvement at Disney World was due to lower costs and guest spending growth, partially offset by lower attendance. Lower attendance reflected the fiscal period impact, which more than offset increases in attendance and occupied room nights.

Iger and CFO Christine McCarthy said on the call that Shanghai Disneyland -- which opened in mid-June -- exceeded expectations in the quarter, its first full quarter in operation. 

Studio entertainment: Continued strength in Finding Dory and Captain America: Civil War weren't enough 

Data source: Disney.

Disney had a rather weak slate of movies released at the very end of the third quarter and in the fourth quarter: The BFG, Pete's Dragon, The Light Between Oceans, and Queen of Katwe. Pete's Dragon and Queen of Katwe didn't meet the company's performance expectations. Even with the help of continuing solid theatrical performance of blockbusters Finding Dory and Captain America: Civil War, which were released in the previous quarter, Disney's operating income in the quarter wasn't strong enough to best the year-ago period's results, which were driven by strong performances by Inside Out, Ant-Man, and Avengers: Age of Ultron.

Year-over-year quarterly studio results are always going to be especially lumpy, as just one or two big blockbusters can make a huge difference in comparables. Investors should particularly focus on annual results in this business. In fiscal 2016, this segment was a hit-movie-making-machine:  

• It released four films that broke $1 billion in worldwide box office (Star Wars: The Force Awakens, Captain America: Civil War, Finding Dory, and Zootopia) and The Jungle Book came very close with $966 million.
• It notched an industry record-breaking $7.5 billion in total box office receipts. 
• Revenue soared 28% year over year, while segment operating income rocketed 37%.

Consumer products and interactive media: Frozen comps remain tough 

Data source: Disney.

The decline in revenue in Disney's smallest segment was primarily due to the discontinuation of its Infinity console game business.

The dip in operating income was largely due to a tough comparable: Toys and other products based on the phenomenally successful Frozen were still selling briskly in the year-ago period. While sales of merchandise based on Finding Dory were robust in the current quarter, they weren't enough to overcome the Frozen comp.

Looking ahead

Disney doesn't provide specific forward guidance. There are numerous catalysts for growth on the horizon in fiscal 2017, with two notables -- one being the release of the Star Wars stand-alone film, Rogue One, ahead of the holidays in mid-December and what should prove to be continued strength at Shanghai Disneyland. 

Notably, Disney plans to use its new BAMTech stake to launch a direct-to-consumer ESPN-branded multisport subscription video streaming service in fiscal 2017.

Iger said on the earnings call that the company expects fiscal 2017 to be a slower growth year, but that its strong recent growth dynamics will continue in 2018 and beyond.