I Still Believe in Disney

Mickey Mouse is being pulled both ways this morning, and I don't know if those tiny mouse legs can take it.

Soleil Securities Group analyst Laura Martin is downgrading Disney (NYSE:DIS) -- from buy to hold -- this morning, lowering her price target on the family entertainment giant from $40 to $23.

In the other corner, this morning's Wall Street Journal is singing Disney's praises in a "Finding Gems in Market Debris" article. "Given the low valuations, stocks like Walt Disney could be poised to rise," reads the caption below a snapshot of a Mickey Mouse-shaped hot air balloon.

Unfortunately, that "rise" isn't coming today. Disney shares opened 5% lower this morning, approaching lows last seen more than five years ago. Between a stock analyst and a financial columnist, Mr. Market is going with the pro.

I couldn't disagree more.

The merit of the bear
There are certainly plenty of reasons to be down on Disney these days. Martin is concerned about the company's debt-to-equity ratio, but there are certainly plenty of other reasons to hurl stones at Cinderella's castle.

We can start with this month's quarterly report. It was a mortal one for Disney. For the first time in CEO Bob Iger's tenure, the company missed analyst earnings estimates. Earnings would have been essentially flat, even after backing out a bad-debt charge related to the failure of Lehman Brothers, and a favorable tax resolution from last year's quarter.

There are plenty of other dark clouds in the area:

• The economic funk is global, and compounded by the strengthening dollar, which could dry up the spigot of overseas visitors to the company's stateside attractions.
• A soft economy has everyone making dire predictions of the deteriorating advertising market, something that will hit ABC hard.
• Many of the Disney Channel properties appear to be peaking. The same can be said for the Pirates of the Caribbean movie franchise. Some celluloid franchises like Narnia already peaked.

Add it up and it's not a good time to be a consumer-facing company. The pitching of stuffed animals at the local Disney Store or new DVDs at the consumer electronics superstore needs improving discretionary income levels to work. Did you see that mall operator General Growth Properties (NYSE:GGP) shed nearly 80% of its value last week on liquidity concerns? The consumer isn't shopping.

The merit of the bull
There is a strong earnings-based valuation argument to be made for Disney, and this morning's Journal made it. Over the last 10 years, Disney's stock has fallen by 25% -- from $28.18 to $21.08 -- but earnings have inched higher in that time. In short, Disney's P/E ratio has gone from 32 a decade ago to just 9 today.

A low P/E ratio isn't necessarily cheap. Homebuilders and financial institutions also had minuscule multiples before collapsing. If earnings begin to crater, P/E ratios shoot higher.

The market certainly seems to feel that way about the media industry. Disney isn't the only TV star fetching single-digit multiples at the moment.

Source: Yahoo! Finance.

Even with earnings projected to slip slightly in fiscal 2009 for some of these companies -- and actually improve slightly at Time Warner and Viacom -- these are ridiculous multiples.

Yes, Disney is actually trading at an earnings premium relative to the sector, but let's sing some of Disney's praises.

• Many of Disney's properties like ESPN and Disney Channel rely more on cable subscription revenue than ad space. If a souring economy finds us spending more time at home, few will cancel their cable and satellite television services.
• Disney's theme parks actually posted a 7% gain in revenue this past quarter. A drop in passport-stamping visitors would hurt, but have you checked out the regional amusement park operators lately? Attendance rose at the largest chains this past summer, with Six Flags (NYSE:SIX) also improving per-capita guest spending during the period.
• Falling fuel prices will aid Disney's booming cruise line business, as the company gears up to double its fleet over the next few years.
• Disney Channel hits like Hannah Montana and High School Musical may be peaking in popularity, but it's clearly better to have bankable franchises heading into the crucial holiday selling season than to be empty-handed the way Disney was a few years ago.

So Disney is cheap. The whole industry is cheap. Earnings are unlikely to improve until the economy does, but Disney is built to weather the storm. When the Journal revisits Disney in 10 years, does anyone really believe that it will still command a single-digit earnings multiple? Throw earnings improvement into the mix and opportunistic buyers may really be at the dawning of the new Disney Decade.

M-I-C. See these other headlines:

• Don't Pity the Theme Parks
• Why Is Everybody Picking on Disney?
• The Stocks You Should Own