Analysis: DIS

On Tuesday, shortly after the closing bell, Walt Disney Co. (DIS) reported a solid top and bottom line beat with its fiscal first quarter earnings results. On the top line, sales of $15.303 billion out paced expectations of $15.161 billion. On the bottom line, adjusted earnings per share of $1.86 (-36% YoY) breezed past expectations of $1.54 per share. Operating income was also better than expected. coming in at $3.655 billion versus $3.256 billion consensus.

Speaking on the release, CEO Bob Iger stated, ""After a solid first quarter, with diluted EPS of $1.86, we look forward to the transformative year ahead, including the successful completion of our 21st Century Fox acquisition and the launch of our Disney+ streaming service. Building a robust direct-to-consumer business is our top priority, and we continue to invest in exceptional content and innovative technology to drive our success in this space."

Before digging into the individual operating segments, we want to remind members that management has reorganized segments this year into Media Networks, the combined Parks, Experiences and Consumer Products, Studio Entertainment and the newly formed Direct-to-Consumer & International (where ESPN+ is now reported).

Starting with Media Networks, sales of $5.92 billion (+7% YoY) came up short versus a $6.11 billion consensus, with Broadcasting sales advancing 12% from the same time last year to $1.935 billion and Cable Networks sales increasing 4% from the year-ago period to $3.986 billion. However, despite the segment revenue miss, segment operating income of $1.33 billion surpasses expectations of $1.075 billion as a 40% annual increase in Broadcasting operating income more than offset a 6% annual decline in Cable Networks operating income. On the release, management noted that, "lower [Cable Networks] operating income was due to a decrease at ESPN and Freeform, partially offset by an increase at the Disney Channels. The decrease at ESPN was due to higher programming costs, partially offset by affiliate revenue growth and an increase in advertising revenue." As for Broadcasting, management called out on the release, "the increase in operating income was due to affiliate revenue growth, increased advertising revenue and higher program sales, partially offset by higher programming costs."

Looking at Parks, Experiences & Consumer Products revenue of $6.824 (+5% YoY) edged out consensus of $6.819 billion while segment operating income of $3.655 billion blew past expectations of $3.256 billion. On the conference call, CFO Christine McCarthy noted, "operating income growth was driven by higher results at our domestic theme parks and resorts, partially offset by lower merchandise licensing and international park results," with operating income at domestic parks benefiting from "higher guest spending at the park and higher occupied room nights at the hotels," despite domestic parks attendance being comparable to the year-ago period. On the international front McCarthy noted that results "were lower in the first quarter versus last year, as growth at Hong Kong Disneyland Resorts was offset by lower results at Shanghai Disney Resort and Disneyland Paris." McCarthy also called out that "per capita spending was up 7% on higher admissions, food and beverage and merchandise spending. Per room spending at our domestic hotels was up 5%, and occupancy was up 3 percentage points to 94%." Regarding trends in the current quarter, which can give us insights into the next release, an important consideration given that Disney does not provide explicit guidance, McCarthy added, "so far this quarter, domestic resort reservations are pacing up 4% compared to prior year, while booked rates are up 1%."

One last thing we would call out is that per the company's 10-Q SEC filing, "The Company currently expects its fiscal 2019 capital expenditures will be approximately $1 billion higher than fiscal 2018 capital expenditures of $4.5 billion due to increased investments at our domestic and international parks and resorts."

As a side note, we believe that as members analyze the quarter, it is important to keep in mind that while we are looking at Disney specific results, this segment in particular can provide insights into broader U.S. consumer trends and sentiment as spending on this front is highly discretionary.

Jumping to Studio Entertainment, sales of $1.824 billion (-27% YoY) came up short of expectations of $1.915 billion. However, operating income edged out expectations, coming in at $309 million versus expectations of $302 million. On the call, McCarthy noted that "higher TV/SVOD and home entertainment results were more than offset by lower worldwide theatrical results, reflecting the phenomenal performance of Star Wars: The Last Jedi, Thor: Ragnarok and Coco last year compared to Ralph Breaks the Internet, Mary Poppins Returns and The Nutcracker this year." Additionally, it worth keeping in mind that given record studio performance in 2018, the company will be facing difficult comps in its fiscal second quarter.

That said, we will see two big releases in the current quarter including Captain Marvel, the company's first female-led superhero movie and a live action adaptation of the animated classic, Dumbo. The caveat, however, is that Dumbo will not be released until the end of the quarter, meaning that the film will only be in the box office for two days before the quarter closes but all prerelease marketing expenses will be recognized in the quarter, making for outsized expenses that will negatively skew reported results. Additionally, speaking to the tough comps being faced this quarter, we remind members that in the second quarter of last year, Disney had several major franchises in theaters including Black Panther and carryover performance from the Star Wars and Coco releases. To this point, we would also note that Disney's fiscal second quarter last year saw the best Studio performance in company history.

Regarding the Studio assets coming over from Fox, including R-rated content such as Deadpool, which is not typical content for Disney, Iger noted "We do believe there is room for the Fox properties to exist without significant Disney influence over the nature of the content. Meaning that we see that there is certainly popularity amongst Marvel fans for the R-rated Deadpool films, we're going to continue in that business, and there might be room for more of that. And there's nothing that we've really seen in the Fox either library or in the activities that Fox is engaging in today from a standards perspective that would be of concern to us, as long as we're very carefully a branding them and making sure that we're not in any way confusing the consumer with product that would be sort of Disney products or the more traditional Marvel product."

Lastly, at Direct-to-Consumer (DTC) and International, sales of $918 million (+1% YoY) missed expectations of $979 million though we would note that results were impacted by an unfavorable 4% foreign currency impact. Additionally, while the segment is currently operating at a loss, results were better than expected coming at a loss $136 million versus expectations for a loss of $149 million. On the release, management noted, "The increase in operating loss was due to the investment ramp-up in ESPN+, which was launched in April 2018, a loss from streaming technology services and costs associated with the upcoming launch of Disney+, partially offset by an increase at our International Channels and a lower equity loss from our investment in Hulu." Furthermore, relating to the Fox acquisition, Iger noted on the call, "the addition of content and management talent from 21st Century Fox will further enhance our DTC efforts and provide opportunities for growth across the company."

Speaking on the company's conference call, Iger stated, "DTC remains our #1 priority. Our corporate reorganization was designed to support our DTC efforts, while providing a greater degree of transparency into our investment and our progress in the space. We remain focused on the programming as well as the technology to drive the success of our DTC business, and we're thrilled with the continued growth of ESPN+," adding that paid subscriptions for ESPN+ have doubled over the last five months to two million. While we did not get much color on Disney+, we did learn that we will get a demonstration of the platform as well as a peak at some of the original content being created for it at the company's April 11 Investor Day.

All in, we believe the quarter to be largely positive, despite the segment revenue misses thanks to improved operating efficiencies leading to better than expected operating margins across the board. We believe the momentum as ESPN+ bodes well for the company's DTC consumer strategy and look forward to learning more at the upcoming Investor Day. The one headwind we would call out for the Investor Day is that we may learn of additional expenses associated with building out that Disney+ platform. However, we believe this is largely expected and partially to blame for shares being unable to breakout to new levels. That said, we believe any additional investments will be worthwhile and that longer-term the company's DTC strategy is a move in the right direction given the ongoing cord cutting trend, a view bolstered this quarter by the strong momentum seen at ESPN+. We reiterate our One rating.