Walt Disney Co. Q1 Earnings Soar on "Star Wars," but Cable Results Feed Into Cord-Cutting Concerns

Source: Disney.

Walt Disney (DIS -1.01%) reported its fiscal first quarter 2016 results after the market closed on Tuesday. The diversified entertainment giant posted strong year-over-year revenue growth of 14%, while adjusted earnings per share soared 28%. The results were driven by the phenomenally successful Star Wars: The Force Awakens, which opened in domestic theaters on Dec. 18 and has smashed countless box office records.

Despite the stellar headline numbers, shares of Disney fell about 4% on Wednesday because of decreased profitability in the media networks segment, feeding into market concerns around "cord-cutting" and "cord-slimming." Concern about the negative effect on ESPN and other Disney cable networks over subscribers who may drop or trim their cable bundles has driven a 27% decline in the stock from its 2015 peak, but the company remains a long-term All-Star.

The key quarterly numbers

Source: Disney

Long-term investors shouldn't get too hung up on quarterly analyst estimates, as Wall Street is notoriously short-term focused. It's worth noting, however, that The House of Mouse comfortably beat revenue expectations of $14.75 billion and crushed the bottom line consensus of $1.45 per share. Adjusted earnings grew at twice the rate of revenue, which means that profit margins greatly expanded. 

The Force Awakens phenomenon drove record quarterly operating income at both Disney's studio entertainment and consumer products & interactive media segments. Here's how the four segments performed.

Media networks: ESPN's profitability drops  

Source: Disney

Within the segment, cable network revenue expanded 9%, while broadcasting revenue increased 7%. Cable network operating income contracted 5% to $1.2 billion, while broadcasting saw a 7% decline.

Regarding the drop in operating income, CFO Christine McCarthy said on the conference call, "[O]perating income would have grown in line with the 8% revenue growth we delivered when adjusted for the timing of the college football playoffs and an adverse impact from foreign exchange."

Cable network operating income fell because of a decrease at ESPN and lower equity income from A&E, partially offset by growth at the domestic Disney Channels. The decrease at ESPN was due to higher programming costs, partially offset by an increase in advertising and affiliate revenue. Affiliate revenue growth was due to contractual rate increases, partially offset by a decline in subscribers and unfavorable foreign currency translation impacts from the strong U.S. dollar.

ESPN results were negatively affected by the timing of its fiscal quarter end relative to when college football playoff bowl games were played, resulting in an increase in programming and production costs. These playoff games aired during the first fiscal quarter, whereas they aired during the second fiscal quarter last year. Some of the higher costs, however, are due to contractual rate increases for key sports rights, including the NFL and college football.

CEO Bob Iger subscribed to a strong offense, spending much time on the conference call sharing positive facts and figures about ESPN. His comments indicate that the company plans to remain nimble as it navigates a somewhat changing marketplace. For background: Disney released its ESPN subscriber numbers in an SEC filing the day before Thanksgiving, revealing they fell from 99 million at the end of fiscal 2013 to 92 million at the end of fiscal 2015. That's an annual subscriber loss of about 3.6%, as customers ditch or slim down their large cable packages.

Iger said, "In the last couple of months, we have actually seen an uptick in ESPN subs[cribers], which is encouraging." He later added, "[W]e believe that we've benefited from the growth of certain light packages that ESPN has been part of, particularly [Sling TV's] Dish."

Cord-cutting concerns, and their effect on profitability, are legitimate. Media networks accounted for 53% of Disney's operating income in fiscal 2015. However, the market could well be underestimating Disney's ability to overcome this challenge and/or compensate for it. This company is masterful at leveraging its intellectual property and has proven just as adept at spotting fantastic acquisitions. These are traits that oftentimes result in unexpected new income sources, which analysts can't accurately project.

Parks and resorts: margin expands on strength in domestic parks

Source: Disney

Disney's second largest segment continues to be a steady performer thanks to continued strength in its domestic operations and a record performance for the Disney Cruise Line. Attendance at the company's domestic theme parks was up 10%, while average spending rose another 10%. Per-room spending at its domestic hotels increased 9%, and occupancy was up three percentage points to 92%. 

The segment benefited from the timing of the fiscal quarter. One week of the New Year's holiday fell into the first quarter this year, shifting forward approximately $9 million in operating income. Excluding this figure, operating margin still increased a robust 20.7%.

Studio entertainment: operating income soars on success of The Force Awakens

Source: Disney

The global success of Star Wars: The Force Awakens was the primary catalyst for this segment. Increased TV/SVOD (subscription video on demand) international distribution and home entertainment results from the sales of Star Wars Classic titles also helped drive operating income growth. 

The Force Awakens has set impressive records:

• In just 20 days after its release, it became the highest-grossing film of all-time (excluding inflation) at the domestic box office, surpassing the $760.50 million generated by Avatar.
• On Feb. 5, it became the first film ever to surpass the $900 million mark in the U.S.
• On Feb. 6, it crossed the $2 billion mark worldwide, making it only one of three films to ever do so, according to Box Office Mojo.

Consumer products: Superhero-like margin thanks to Star Wars and Marvel

Source: Disney