Disney’s Q3 FY 15 Earnings Preview: Look For Cable Networks Growth Amid A Tough Comp And Currency Effects

Disney (NYSE:DIS) will report its Q3 earnings for fiscal 2015 on August 4th. (The fiscal year ends with September.)  ((Disney’s Press Release)) We expect Disney to post continued growth at its theme parks but ESPN could face some headwinds amid lower ratings and a tough prior year comparison. Looking at studio entertainment, the company will surely benefit from the success of Avengers: Age of Ultron and Inside Out, but Tomorrowland’s dismal performance is likely to be a drag. Moreover, strength in the U.S. Dollar may further impact the foreign box-office collections in the June quarter. ABC broadcasting saw higher ratings for 2014-15 television season with hit fresh shows such as How To Get Away With Murder and Black-ish and this likely boosted the advertising income. Overall, we expect mixed results from Disney with solid growth at its theme parks driven by higher attendance and guest spending, while cable networks may face some headwinds amid ratings woes and higher programming costs.

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Lower Ratings And A Tough Comparison At ESPN Likely To Weigh On Cable Networks Division

ESPN’s ratings declined 11% for primetime and 25% in total day for the June quarter. ^[1] This can be attributed to 2014 coverage of FIFA world cup and lower viewership at the 2015 College World Series. Lower ratings will likely weigh on the network’s advertising revenues. ESPN has spent billions of dollars in acquiring the programming rights and this has weighed on its bottom line in the recent past and this could well be the case in June quarter as well.

We estimate that ESPN accounts for more than 30% of Disney’s stock value. The network has been a leader in sports programming and will remain so for the foreseeable future as it has renewed most of its key programming deals in the past few years. While Q2 could be an exception of ratings decline amid a tough comparison, ESPN as well as sports programming in general have been doing well in recent quarters. In fact, ESPN was the most watched cable network in 2014. Given the viewership trends, we believe ESPN will continue to raise its monthly subscription fees at a steady pace. We estimate fees will grow from $6 currently to an estimated $9 in the coming years. This will translate into annual revenues of over $10 billion and if we add the advertising revenues, the figure will be north of $15 billion. An estimated EBITDA margin of 47% will translate into EBITDA of over $7 billion, representing 25% of Disney’s overall EBITDA. The contribution will be even higher if we account for ESPN’s sister channels.

Given the massive size of ESPN, it is important for Disney to hold on to its programming deals. Other networks such as Fox Sports 1 (FS1) are inching up slowly. FS1’s recent coverage of Women’s Soccer World Cup was a stellar success and generated high viewership.

Theme Parks Should Continue To See Steady Growth

Disney’s theme parks will see the full benefits of increased ticket prices. The company has been witnessing attendance growth in its theme parks for quite some time now and it should continue this trajectory. This can be primarily attributed to the improving U.S. economy and Disney’s investment in new attractions within its resorts. U.S. disposable personal income has been on an uptrend and grew from $13,266 billion in January 2015 to $13,429 billion in May. ^[2] A better macroeconomic environment should spur demand for luxuries, travel, leisure, theme parks, entertainment, etc.

Past month, Disney revealed its Shanghai attractions, which were very different from its usual theme parks elsewhere. The much hyped $5.5 billion theme park resort will feature attractions based on Marvel comics, Star Wars and others based on Chinese culture. ^[3] We will be looking forward to the company’s management commentary on Shanghai and if they have any similar plans for its other properties. Also, Disney’s take on $1 billion investment in its Disneyland Park in California in order to protect itself from a potential entertainment tax. ^[4]

On a separate note, Disney should see solid growth at its consumer products and interactive unit, primarily reflecting the benefits from its new Shanghai store and continued demand for its Infinity video game.

Currency Headwinds And Tomorrowland May Be A Spoiler At Studio Entertainment

Disney will surely benefit from the wide success of Avengers: Age of Ultron, which has grossed close to $1.40 billion at the global box-office while it was made with a production budget of $250 million. ^[5] Similarly, Disney’s Inside Out was successful at the box-office. However, a dismal performance of Tomorrowland will likely be a drag on the bottom line. Moreover, given the strength in U.S. Dollar, it will surely weigh over the foreign performance in the June quarter.

Looking forward, Disney has a solid lineup in the coming months, including much hyped Star Wars: The Force Awakens, The Jungle Book and a sequel to Captain America. These movies should drive growth for the studio in 2016, and we estimate the segment revenues to be over $8 billion. An estimated EBITDA margin of 28% will translate into EBITDA of over $2.25 billion by end of 2016, representing more than 10% of the company wide EBITDA.

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1. FS1’s Q2 Viewership Up Big With New Programming, While MLB Net Sets New Record, Sports Business Daily, July 9, 2015 [↩]
2. United States Disposable Personal Income, Trading Economics [↩]
3. Exclusive attractions unveiled for Shanghai Disney Resort, Want China Times, July 17, 2015 [↩]
4. Disney seeks $1 billion Disneyland, California Adventure expansion for no new gate tax, The Republic, June 26, 2015 [↩]
5. Avengers: Age of Ultron, Box Office Mojo [↩]