Disney Fires on All Cylinders in 2Q

 Walt Disney (DIS) reported impressive fiscal second-quarter results, with its cable networks and branded businesses demonstrating their pricing power. Our $50 fair value estimate is unchanged, and we think there is still a bit more upside in the shares. A fair deal of optimism is priced into the shares today, but as shown as recently as last summer, when the shares got as low as $31, one earnings hiccup or macroeconomic head fake could give patient investors a better buying opportunity for this wide-moat company. We remain pleased with the company returning capital to shareholders via stock buybacks. Over the past six months, Disney has repurchased 51 million shares (about 3% of shares outstanding) at an average price just north of $37.

Revenue and earnings per share were up 6% and 18%, respectively. Cable network sales improved 12% (9% after adjusting for deferred affiliate revenue) thanks to growth at ESPN and the worldwide Disney Channels, which are now in more than 167 global markets, up from 19 a decade ago. We think Disney Channels is an underappreciated asset, given the international growth runway and ability to promote the Disney brand to all corners of the world. Advertising growth at ESPN was 6% higher after excluding the benefit of two extra bowl games and NBA games in the quarter. On a trailing-12-month basis, cable network operating margins matched its recent high of last quarter at 41.4%. We view the increase in sports rights fees, especially for NFL and college football, as manageable and believe the cable networks can maintain margins in excess of 40% over the next five years.

The parks and resorts business was the standout performer in the quarter, with sales up 10.2% (11.0% domestic and 6.6% international). Attendance at domestic parks increased 7% with 5% higher per capita spending as Disney continues to gradually flex its pricing power post-recession. We think the parks trends should continue, especially in light of the improvements occurring in Orlando and Anaheim. We view the current peak capital expenditures as necessary costs that will come down after this year and help improve free cash flow for Disney.

The recent success of The Avengers at the global box office validates our thesis that Disney's brands are as strong as ever. A sequel to The Avengers is in the works, and sequels are already slated for several of the hit characters in movie. In fact, demand for the brand is so strong that Disney alluded to shortages of some of its licensed toy products in some retail channels outside Disney's control. Relative to the higher-margin cable network business, the branded half of Disney is more capital-intensive and requires acquisitions like Marvel. However, we view the wide moat on the Disney brand lasting for well more than two decades into the future.

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