Intrinsic Value Assessment of

WALT DISNEY CO. (DIS)

NOVEMBER 27, 2017 This article was written with David J. Flood from The Investor’s Podcast

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

IntroductionWaltDisneyCo.isanAmerican-basedmultinationalmassmediaandentertainmentconglomerate.Thecompanyoperatesthroughfourbusinesssegments,namely‘TheWaltDisneyStudios,’‘ParksandResorts,’‘MediaNetworks,’and‘DisneyConsumerProductsandInteractiveMedia.’WaltDisneyCo.iscurrentlyamemberoftheFortune500listwithamarketcapof$155Billion.Itsrevenuesandfreecashflowsforthepreviousfinancialyearwerearound$55.1Billionand$8.7Billionrespectively.Thecompany’scommonstockhasfluctuatedbetweenalowof$96andahighof$116overthepast52weeksandcurrentlystandsataround$102.IsWaltDisneyCo.undervaluedatthecurrentprice?

TheIntrinsicValueofWaltDisneyCo.TodeterminetheintrinsicvalueofWaltDisneyCo.,we’llbeginbylookingatthecompany’shistoryoffreecashflow.Acompany’sfreecashflowisthetrueearningswhichmanagementcaneitherreinvestforgrowthordistributebacktoshareholdersintheformofdividendsandsharebuybacks.BelowisachartofWaltDisneyCo.’sfreecashflowforthepasttenyears.

Asonecansee,thecompany’sfreecashflowhasbeenonamoderateupwardtrendoverthepastdecade,growingatanannualaveragerateof13%.TodetermineWaltDisneyCo.’sintrinsicvalue,anestimatemustbemadeofitspotentialfuturefreecashflows.Tobuildthisestimate,thereisanarrayofpotentialoutcomesforfuturefreecashflowsinthegraphbelow.

Intrinsic Value Assessment of

WALT DISNEY CO. (DIS)

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

Whenexaminingthearrayoflinesmovingintothefuture,eachonerepresentsacertainprobabilityofoccurrence.Theupper-boundlinerepresentsa13%growthratewhichisbasedonthehistoricalrateofgrowthinfreecashflow.AssumingWaltDisneyCo.weretogrowfreecashflowatthisrateforthenextdecade,itwouldbegenerating$30Billionby2027,morethantripleitspresentlevel.Thisisanextremelyoptimisticassumption,andassuch,ithasbeenassigneda0%probabilityofoccurrence.Themiddlegrowthlinerepresentsa4%growthrate.Thisisbasedonthe10-yearhistoricalrevenuegrowthrate.Revenuestendtobefarmorestablethanearnings,andassuch,offeramorerealisticassumptionforestimates.Forthisreason,ithasbeengivena70%probabilityofoccurrence.Thelowerboundlinerepresentsa0%growthrateinfreecashflowgrowthandhasbeenassigneda30%probabilityofoccurrence.ThislowerboundrateassumesthatfreecashflowgrowthstagnatesasconsumersrejectlegacymediacompaniesenmasseinfavorofemergingonlineplayerssuchasNetflixandAmazon.WaltDisneyCo.hasrecentlystoppedpublishingtheircontentonNetflixandisworkingontheirownplatformfortheirownproductionsbecausetheywishtofullycontroltheentiredistributionandtoprotectthebrand.

Assumingthesepotentialoutcomesandcorrespondingcashflowsareaccuratelyrepresented,WaltDisneyCo.mightbepricedata5.3%annualizedreturnifthecompanycanbepurchasedattoday’sprice.We’llnowlookatanothervaluationmetrictoseeifitcorrespondswiththisestimate.

WaltDisneyCo.currentlytradesataP/FCFof18x,whichisclosetothefirm’shistoricalmedianaverageof19XandabovetheIndustrymedianof13.3x.Thissuggeststhatthecompanyisovervaluedrelativetotheindustryandinlinewithitshistoricalaverage.IfweinvertWaltDisneyCo.’sP/FCFratio,wegetitsFCFyieldwhichiscurrentlyaround5.4%.Thisisinlinewithourpreviousestimate.Finally,we’lllookatWaltDisneyCo.’sPEGratio,ametricusefulforestimatingthefairvalueofacompanyrelativetoitsearningsgrowthrate,toseehowitfairs.Atpresent,thecompany’sPEGratiostandsat1.35.Thisisaboveafairvalueof1,suggestingthatthefirmismarginallyovervalued.Takingallthesepointsintoconsideration,itseemsreasonabletoassumethatWaltDisneyCo.istradingatamarginalpremiumtofairvalueatpresent.Further,thecompanymayreturnaround5%atthecurrentpriceiftheestimatedfreecashflowsareachieved.Now,let’sdiscusshowandwhythesefreecashflowscouldberealized.

TheCompetitiveAdvantageofWaltDisneyCo.WaltDisneyCo.hasvariouscompetitiveadvantagesoutlinedbelow.

• BrandValue.WaltDisneyCo.’smostpowerfulcompetitiveadvantageisitsportfolioofbrands.AccordingtoForbes2017globalbrandvaluereport,thevalueofWaltDisneyCo.’sbrandis$43.9

Intrinsic Value Assessment of

WALT DISNEY CO. (DIS)

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

Billion.ThisportfolioincludesDisney,StarWars,Marvel,andESPN.WarrenBuffettisattractedtocompanieswhichearnhighreturnsfrombrandingpowersincetheseintangibleassetsarethehardestforacompetitortoreplicate.ThepowerofthesebrandsalsoallowsthecompanytoownwhatBuffettcallsa‘shareofmind.’Abrandownsashareofaconsumer’smindwhenthelatterassociatespositiveexperiencesoremotionswithit.Thiscreatesasenseofloyaltybetweentheconsumerandthebrandwhichresultsinrepeatcustomandpricingpower.

• ProprietaryContent.WaltDisneyCo.ownsahugecatalogofproprietarycontentincludingtheDisneycartoonfranchise,theStarWarsfranchise,andtheMarvelfranchise.Thisenviablelibraryofnearly500filmsand7,000TVepisodesallowsthecompanytogeneratecontinuingrevenuestreamsthroughdirectsalesandlicensingfees.

• VerticalIntegration.WaltDisneyenvisagedthesynergiesthatcouldbecreatedthroughverticalintegrationwaybackin1957.Thechartbelow,knownasthe‘SynergyMap,’showshisvisionforthecompany’scorestrategy.

ThischartisstillafairlyaccuraterepresentationofWaltDisneyCo.’sbusinessmodeltoday.Thecompanyinvestsincreativetalenttocreateoriginalcontent,brands,andfranchises.Thesecanthenbelicensedandcross-soldthroughmerchandise,upsoldasphysicalexperiencesatthemeparksandotherevents.UnlikeahorizontalplatformsuchasNetflix,whichonlyhasonemethodtodistributeandmonetizecontent,WaltDisneyCo.cancreateandmonetizeasinglecharacterthroughmovies,TVshows,toys,memorabilia,liveshows,andthemeparks.Thismeansthatforeverydollarinvested,thecompanygetsmorebackinprofitthanitscompetitors.Thechartbelowshowshowthesesynergiestranslateintosuperioreconomicperformance.

Intrinsic Value Assessment of

WALT DISNEY CO. (DIS)

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

WaltDisneyCo.’sRisksNowthatWaltDisneyCo.’scompetitiveadvantageshavebeenconsidered,let’slookatsomeoftheriskfactorswhichcouldimpairmyassumptionsofinvestmentreturn.

• WhileWaltDisneyCo.possessesmultiplecompetitiveadvantages,therestillexistsapossibilitythatoneofitsrivalscouldmountachallengetoerodeitscompetitiveadvantagesandmoveonitsmarketshare.ThesecouldincludeotherlegacymediafirmsornewentrantssuchasNetflixorAmazon.

• Theemergenceofaseriouseconomiccrisis,similartothatwitnessedin2008,couldmateriallyimpactthecompany’srevenuesandprofitsleadingtolowergrowthinthecomingyears.WhileWaltDisneyCo.possessesnumerouscompetitiveadvantages,afallinconsumerconfidenceandspendingwouldbedetrimentaltothecompany’seconomicperformance.

• Theriskofobsolescencecouldariseifthecompanyfailstoaddresstherisksposedbydisruptivetechnology.IfWaltDisneyCo.wishestomaintainitscompetitiveposition,itisimportantthatthecompanyaddressesthethreatsposedbyonlinecontentproviderssuchasNetflixandAmazon.Itmust,therefore,reinvestitscapitalinaneffectiveandefficientmannertomaintainitsbrandingpower,generatenewandcompellingproprietarycontent,andtoadaptitsbusinessmodeltothechanginghabitsofmediaconsumptionamongstconsumers.

OpportunityCostsWheneveraninvestmentisconsidered,onemustcompareittoanyalternativestoweighuptheopportunitycost.Atpresent,10-yeartreasuriesareyielding2.37%.Ifwetakeinflationintoaccount,therealreturnislikelytobecloserto1%.TheS&P500IndexiscurrentlytradingataShillerP/Eofx31.4and,atpresent,islikelytoreturnaround2-3%.WhileWaltDisneyCo.istradingatamarginalpremiumtofairvalue,itstillappearstoofferahigherrateofreturnthanbothU.S.treasuriesandtheS&P500Index.Thereare,however,otherindividualstockstobefoundwhichmayofferamorefavorablereturnrelativetotheriskprofile.

MacroFactorsInvestorsmustconsidermacroeconomicfactorsthatmayimpacteconomicandmarketperformanceasthiscouldinfluenceinvestmentreturns.Atpresent,theS&PispricedataShillerP/Eof31.4.Thisisaround87%higherthanthehistoricalaverageof16.8,suggestingthatmarketsareatelevatedlevels.U.S.unemploymentfiguresareata30-yearlow,suggestingthatthecurrentbusinesscycleisnearingitspeak.U.S.privatedebt/GDPcurrentlystandsat199.6%andisatitshighestpointsince2009whenthelastfinancialcrisispromptedprivatesectordeleveraging.

SummaryThefutureforWaltDisneyCo.looksfavorableifitcanmaintainitscompetitiveadvantagesandadapttothechangesinmediaconsumptionbyconsumers.ThecompanyappearstobetakingthisissueseriouslyandhasrecentlyannouncedthatitispullingitscontentfromNetflixandopeninganad-free‘direct-to-consumer’streamingplatform.WaltDisneyCo.CEOBobIgerannouncedthattheDisney,StarWars,Pixar,andMarvelcatalogwouldbemovedtotheplatformalongwithafilmlibraryof400-500moviesandaround7,000TVepisodesattheBankofAmericaMerrillLynch2017Media,Communications&EntertainmentConference.

ThecompanyalsoplanstocreatefourtofiveneworiginalDisneybrandedfilmsandalargevolumeoforiginalshort-formcontentwhichwillbeexclusivetoitsstreamingservice.Thefirm’sESPNsportsnetworkwillalsobehostedontheplatform,andthiswillcontinuetofeaturetargetedadvertisements.WaltDisneyCo.isalsointalkswith20thCenturyFoxoverapossiblemajorassetsacquisition.Shouldtheacquisitionplayoutwell,itwouldfurthergrowthecompany’sportfolioofproprietarycontentandincreaserevenuesandearnings.

Intrinsic Value Assessment of

WALT DISNEY CO. (DIS)

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

Inthepast,thecompanyhasbeencriticizedfornotdistributingenoughearningsindividends,butmanagementseemstohavetakennoteandactedaccordingly.Thisisevidencedbythefactthatdividendgrowthhasincreasedfroma10-yeargrowthrateof21.10%toa5-yearand3-yeargrowthrateof23.70%and22%respectively.Furthermore,thecompanyhasgrowndividendsby9.90%inthelastyearalone.Inthefiscalyear2016,thecompanyreturned$2.3Billionindividendsbutallocatedaround89%ofitsfreecashflowsonsharebuybacks.Indollarterms,thefirmspent$7.5Billiononbuybacksandcanceledaround73.8millionsharesatanaveragecostpriceof$101.60pershare.Thereisplentyofroomfordividendstocontinuetogrow.Ifmanagementscalesbackitsbuybacksinfavorofgreaterdividendgrowth,thesharepriceislikelytomoveup.

Atpresent,WaltDisneyCo.appearsmarginallyovervaluedwithanestimatedreturnofaround5%.Whilethecompany’sstockpriceiscurrentlytradingatapremiumtofairvalue,itiscertainlyonetowatch.Shoulditssharepricedeclinetoamorereasonablelevel,itwouldbeworthyofseriousconsiderationbyinvestors.

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