Walt Disney's Q2 Earnings Rise 11% on Box Office Hits, but Cord-Cutting Concerns Resurface

By Markets Fool.com

Image source: Disney.

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Walt Disneyreported its fiscal second-quarter2016 results after the market closed on Tuesday. The diversified entertainment giant posted year-over-year revenue growth of 4.1% while adjusted earnings per share rose 10.6%.

Shares of Disney fell 5.5% in after-hours trading on Tuesday and at 10:15 a.m. Wednesday were down about 4.3% from the previous day's close. Adjusted EPS growth of nearly 11% is solid for a company of Disney's size. However, the market was no doubt disappointed that earnings and revenue fell short of Wall Street's expectations. Renewed cord-cutting concerns also likely played a role in the stock's decline.

Key numbers

Metric

Fiscal Q2 2016

Fiscal Q2 2015

YOY Growth

Revenue

$12.97 billion

$12.46 billion

4%

Operating income

$3.82 billion

$3.48 billion

10%

Net income

$2.14 billion

$2.11 billion

2%

GAAP earnings per share

$1.30

$1.23

6%

Adjusted EPS

$1.36

$1.23

11%

YOY = year-over-year. Data source: Disney.

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Disney took a $147 million charge related to the discontinuation of its Disney Infinity video games business. The adjusted EPS result exclude this charge.

Long-term investors shouldn't pay too much heed to analysts' estimates, as Wall Street is focused on the short term. However, market reactions are often explained by these expectations. So, it's worth noting that The House of Mouse fell short of both revenue and earnings expectations -- its first earnings miss in five years. Analysts were expecting adjusted earnings of $1.40 per share on revenue of $13.21 billion.

Here's how the four segments performed.

Media networks: Operating margin rose, but ESPN lost more subscribers

Metric

Fiscal Q2 2016

Fiscal Q2 2015

YOY Growth

Revenue

$5.79 billion

$5.81 billion

--

Operating income

$2.30 billion

$2.10 billion

9%

Operating margin

39.7%

36.1%

60 basis points

Data source: Disney.

Results were a mixed bag for Disney's largest and most profitable segment, which has been under extreme scrutiny since last August when concerns about cord-cutting and cord-slimming negatively affecting the profitability of the lucrative cable networks business first surfaced. Within the segment, cable networks' revenue declined 2% to $3.96 billion, while broadcasting revenue increased 3% to $1.84 billion. Cable networks' operating income rose 12% to $2.02 billion, while broadcasting experienced an 8% revenue decline to $278 million.

Cable networks' operating income rose due to an increase at ESPN -- largely a result of a "shift" in the fiscal calendar relative to last year -- partially offset by lower equity income from A&E. The increase at ESPN was due to lower programming costs and higher affiliate revenue, partially offset by a drop in advertising revenue. Results benefited from the timing of the quarter relative to when college football playoff bowl games were played, which resulted in a decrease in programming costs and advertising revenue. One of these games aired in the second quarter, whereas seven games aired in the second quarter of the prior fiscal year.

ESPN's affiliate revenue growth was due to contractual rate increases, partially offset by a decline in subscribers -- a fact that could reignite the market's jitters.

Parks and resorts: Margin expanded on strength in domestic parks

Metric

Fiscal Q2 2016

Fiscal Q2 2015

YOY Growth

Revenue

$3.93 billion

$3.76 billion

4%

Operating income

$624 million

$566 million

10%

Operating margin

15.9%

15.1%

80 basis points

Data source: Disney.

Disney's second-largest segment continues to be a steady performer thanks to continued strength in its domestic business, though there was a slight chink in its armor related to park attendance.

Guests shelled out more money, on average, for food, beverages, and merchandise while visiting Disney's domestic operations. They also had to open their wallets wider due to higher average ticket prices at domestic theme parks and the cruise line, and higher average hotel room rates. Attendance at domestic theme parks was relatively flat, as an increase at Disneyland was offset by a "modest decrease" at Disney World.

While one quarter hardly makes a trend, going forward investors should keep their eyes on park attendance figures, particularly at Disney World. The year-over-year dip could be a one-off thing that's bound to occasionally happen, but it also might indicate that some consumers have reached a saturation point with respect to Disney's ticket price increases.

Studio entertainment is riding high thanks largely to 2016's current global box office champ Zootopia. Image source: Disney.

Studio entertainment: Results unleashed by Zootopia and The Force Awakens

Metric

Fiscal Q2 2016

Fiscal Q2 2015

YOY Growth

Revenue

$2.06 billion

$1.69 billion

22%

Operating income

$542 million

$427 million

27%

Operating margin

26.3%

25.3%

100 basis points

Data source: Disney.

Studio entertainment posted fantastic results thanks to the phenomenally successfulStar Wars: The Force Awakens and 2016's current global box office champ Zootopia.

The Force Awakens, whichopened in domestic theaters on Dec. 18, shattered box office records. The movie was still going strong domestically in the fiscal second quarter, and didn't open in certain international markets until January. Disney Animation's whimsicalZootopia had rung up theater ticket sales of $959 million worldwide as of midday May 10.It was released domestically on March 4, which means that about a month's worth of theater receipts were included in the quarter's results.

Consumer products/interactive media: Results fell across the board

Metric

Fiscal Q2 2016

Fiscal Q2 2015

YOY Growth

Revenue

$1.19 billion

$1.21 billion

(2%)

Operating income

$357 million

$388 million

(8%)

Operating margin

30%

32.1%

(201 basis points)

Data source: Disney.

Lower operating income was primarily due to the impact of foreign currency translation due to the strengthening of the U.S. dollar relative to other major currencies, lower operating margins and comparable-store sales at the company's retail business, and lower results for Infinity. (Disney is discontinuing its video games business.) These decreases were partially offset by higher licensing revenue, driven by Star Wars-based merchandise.

Like studio entertainment, this segment's results are prone to be particularly lumpy, so the year-over-year revenue and operating income declines aren't a concern, in my view. This is especially true since currency factors were largely at play. It's best to look at this segment with a wider time lens than a quarter -- and, if we do that, its results are moving in the right direction.

Looking ahead

Disney's quarterly results were solid, not spectacular, but each quarter can't be dazzling, especially for such a large company. As long as metrics continue to move in the right direction, so should the stock over the long term.

The company doesn'tprovide forward guidance, but it has some exciting catalysts for growth on the horizon. Most notable is the opening of Shanghai Disneyland on June 16.All signs point to high demand for Disney's first park in mainland China.

Studio entertainment's powerful movie pipeline should continue to help drive results in Q3 and beyond. The Jungle Book,which opened in April, and Captain America: Civil War, which debuted internationally in April and domestically last weekend, should put some superhero-like strength in Q3's results. These movies are currently 2016's No. 2 and No. 4 top-grossing films worldwide, respectively, with Captain America likely to surge higher soon. Wrapping up the Q3 slate areAlice Through the Looking Glass, which hits the silver screen later this month, and Finding Dory,Pixar's long-awaited sequel to the belovedFinding Nemo,which opens in June.

The article Walt Disney's Q2 Earnings Rise 11% on Box Office Hits, but Cord-Cutting Concerns Resurface originally appeared on Fool.com.

Beth McKenna has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.