August 17, 2016

Analysis on Disney stock

A number of subscribers have asked me to describe the bull case for Disney (DIS) . Examining the opposite case that one holds is a useful exercise as no one has the concession on truth in the investment business.

While I don't endorse to the bull case for Disney ... here it is, as I see it:

The bull case is the company's cost of capital -- and not operations or what resides on the income statement.

Disney has a bit more than $15 billion of net debt on its balance sheet. It also has $17 billion of 12-month trailing Ebitd. Ergo, leverage is under 1x. As a means of comparison -- Time Warner (TWX) is at 3x and Viacom (VIA) is at over 3x (and rising).

Today, Disney can borrow $30 billion or more and probably not offend the rating agency minders. Even more interesting is that the average cost of the company's debt is probably under 2% before the tax deduction. Trailing 12-month interest is only a little over $200 million. Put another way, cash flow covers interest over 85x (over 6x is viewed as reasonably conservative).

Over time and very quietly, Disney has bought stuff for cash and then paid off the purchase by using the cash flow of the acquired entity to buy back its own stock. The "stuff" includes Pixar, Marvel and LucasFilm. I suspect the latter will be paid off from its cash flow in under two years as "Star Wars: Rogue One" is released. Share count at Disney is down close to 25% from peak levels.

So, it is reasonable to expect a lot more share repurchase activity from the company.

Through nine months, the company has repurchased $6.6 billion in shares. Twelve-month trailing Ebitd is 10x, indicating a 10% return from buying the stock. Each share bought results in not having to pay the $1.42 after-tax dividend. Thus, the financing cost of share repurchase is negative.

While reasonable people may differ on the unit growth of the cable networks and Disney's least squared earnings growth projections, the company will (under almost any assumptions) generate large amounts of free cash flow.