DIS Summary: Feeling the Pinch

Disney (DIS - commentary - Cramer's Take) finally hit the "Wall-E" that all exporters are smacking up against as the dollar continues its climb and the domestic economy continues its descent.

The Mouse reported EPS of 43 cents, missing the street by 6 cents, on a 5.8% increase in revenue to $9.45 billion that did modestly beat the consensus.

Management led off by outlining the impact of the economy on Disney's business. The total destruction of the auto industry is starting to flow through the media results, since automakers are (were?) big advertisers, while the amusement parks held up until quarter end (but not much after that). Retail "could" be affected during the holidays, but "certainly" will be in 2009. Disney is not immune from economic impact, but as franchises go, its one of the better ones in which to take shelter during the storm.

By segment:

• Media networks sales were up 4% to $4.2 billion with income flat at $1.1 billion. ESPN, Disney Channel and ABC Family drove growth in cable network operating profit. Meanwhile, broadcasting widened its loss to $150 million as adverts collapsed at ABC and the local stations. Automobile and consumer electronics are traditionally the largest categories of advertisers, and autos especially are sucking wind for obvious reasons.

  Management suspects the Olympics also sucked some oxygen from the room. Nonetheless, they were not terribly downbeat about this segment. Advertising is less than 30% of cable revenue (and less than 20% of overall corporate revenue), so most of the pain is going to come quickly and be absorbed. Broadcast is garnering higher CPMs despite lower ratings, and the higher pilot costs that helped sink profit this quarter are now waning.

• Parks and resorts grew revenue 7% to $3.0 billion, while shrinking income 4% to $412 million. Paris and Disney World drove the increase. Paris notably had higher ticket prices, better foreign-exchange impact (vs. a year ago) and good room pricing.

  Higher ticket pricing resulted in a 4% increase in guest spend. However, profit tanked on higher labor and other cost inflation at Walt Disney World, higher fuel and maintenance costs at the Cruise Line, and higher labor in Paris. Management admitted that bookings tanked in October, running down 10% year over year.

  They didn't want to yet admit defeat, noting that people might be waiting to see what the economy does, and thus are delaying vacations, or are simply shrinking their booking window. They could also be waiting for better deals. Management is obliging, unveiling a big promotion tonight designed to extend length of stay. They are also emphasizing the "Celebration" promotion, noting that 70% of people travel in conjunction with a celebration of some sort.

  Management feels that they are better at managing park variable expenses after their 9/11 experience. They claim there is alot of variable expense in their cost structure, so that they can reduce hours, staffing, food, frequency of entertainment. They don't expect to see the same margin decline they saw in 2001, due to the variable expense management, and a revenue mix skewed to more vacation club, cruise line, and value priced rooms. We'll see ... it is still a very high fixed-cost business.

• Studio entertainment revenue decreased 5% to $1.5 billion, with income cut nearly in half to $98 million. Income was hit by less domestic theatrical distribution reflecting weak new films, and higher marketing expenses for releases after the end of the quarter (mainly Beverly Hills Chihuahua and HSM3). They did see some success: Tinkerbell sold 2 million DVDs in the first seven days of release. Three more Tinkerbells are coming in the series.
• Consumer products sales grew 41% to $812 million; income was also up 14% to $176 million. Licensing was good, thank you. As for "tween" brands Hannah and HSM, the stores increased revenue, but that was mainly due to the repurchase of the North American stores, and they still negatively affected margins.

Although the writing should have been on the Wall-E for investors, they were still surprised by the results, sending the stock down nearly 5% after hours. The suddenness of the bookings drop in October is probably the root of the "surprise," as is the realization that auto ad spending is a huge looming shadow, since those companies are on the verge of bankruptcy. Despite it all, Disney is one of the strongest brand companies in the world, and it will be able to ride out the recession better than most. It may be a good place to hide out once the valuation is right.

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At the time of publication, Dvorchak was long/short..., although positions can change at any time.

Gary Dvorchak is a managing partner of Aviance Capital Management, a Sarasota, Fla.-based institutional asset manager that manages $200 million in growth and value equities and fixed income. Dvorchak holds a master's degree in business administration from Northwestern University and a bachelor's degree in computer science from the University of Iowa.