Evaluate the Quality of Disclosure
a) Does the company provide adequate disclosures to assess the firm’s business strategy and its economic consequences?
The company uses the Letter to Shareholders in their annual report to clearly layout the firm’s industry conditions, its competitive position, and management’s plans for the future. In the latest letter to shareholders, the Company points out their success throughout the year in the production of two animated films, the announcement of China’s go-ahead to build a new theme park in Shanghai and the acquisition of Marvel entertainment. At the same time it points out how several key businesses were affected as result of the severe global economic downturn and an acceleration of secular challenges.
b) Do footnotes adequately explain the key accounting policies and assumptions and their logic?
Footnotes do explain in a clear and organized manner. Changes in accounting policies are explained adequately to let you understand the reasons as well as the impact in the final results.
c) Does the firm adequately explain its current performance?
Management’s Discussion and Analysis provides a narrative on the Company’s financial performance and condition that should be read in conjunction with the accompanying financial statements. It includes the following sections: Consolidated Results, Business Segment Results, Non-segment Items, Pension and Benefit costs, Liquidity and Capital Resources, Contractual Obligations, Commitments, and Off Balance Sheet Arrangements, Accounting Policies and Estimates, Accounting Changes, and Forward-Looking Statements. All these clearly explain the Company’s current performance.
Financial Analysis – Multiyear Analysis/Comparisons
ROE Decomposition
Return on Equity (ROE) is one of the most important finance profitability metrics. It is a measure of how much a company earned in comparison to the total amount of shareholder equity found on the balance sheet.
Below you will find Disney’s ROE decomposition model. Three very important metrics are provided by this model - Profitability, Efficiency, and Solvency/Leverage indicators of the company.
These metrics help understands risks and opportunities faced by the company as well and can help take action when it is most appropriate.
During the twentieth century, the S&P 500, which is a measure of the biggest and best public companies in America, averaged ROE's of 10% to 15%. In 2009, Disney has a ROE of 10% which is a “double digit ROE”. Considering that the US is currently under “The Great Recession”, Disney has proven to still be productive. Disney’s financial leverage is under the upper acceptable limit of 2: 1, and does not have a substantial amount of debt maintained. This return on equity makes it likely for it to be capable of generating cash internally and proves to be a sound and safe investment.
Major Competitors
Disney is a diversified media conglomerate with licensing rights to a large number of the most popular and legendary characters including Mickey Mouse and Winnie the Pooh. Disney has a vast library of animated movies featuring these characters along with several theme parks around the world. Disney produces live-action and animated films under a number of names and owns ABC, Disney Channel and ESPN. Additionally, Disney owns stakes in A&E, The History Channel and Lifetime networks.
Disney uses this broad multi-pronged distribution network to create a competitive advantage for among and between its business units. The company focuses on maintaining the strength of its brand and the quality of its products. In recent years it has invested in technology to provide customers with access to its entertainment product on multiple platforms and locations. Disney continues to expand globally to extend its brand to customers around the world.
One of its most significant actions in recent years was the acquisition of Pixar. This acquisition was seen as reinforcing Disney’s commitment to high-quality animation. In addition to bringing Steve Jobs to the Disney board, the integration of Pixar added the talented John Lasseter to the company.
Major Competitors
Financial Overview
Growth: Disney has seen average sales growth of 2.5% over the past three years and forecast steady growth of 3 – 4% over the next 5 years.
Profitability: Disney has maintained operating margin of more than 18% the past three years and expects to maintain this level of profitability.
Financial Strength: Disney is financially solid with debt at a low percentage of capitalization. Interest expense coverage is 12x EBIT.
Financial Highlights
News Corporation
Company Overview
News Corporation is a media conglomerate with widely diversified assets including filmed entertainment, television, cable network programming, magazine, newspapers, book publisher HarperCollins and online properties including MySpace. News Corp. relies on its “old media” properties (books, newspapers and films) to support high growth assets like cable television. The company aggressively pursues growth through acquisitions to either support existing businesses or to enter new markets. About half of its revenues come from outside the U.S. The company is led by Rupert Murdoch who controls 40% of the voting powers. Successful ventures include the Fox Network and Fox News Channel. However, the company has struggled with recent acquisition of Dow Jones and MySpace.
Financial Highlights and Comparison
Financials ($ in millions)
Revenue: News Corp revenues are on par with Disney, but overall growth is 2% vs. 4% at Disney. Revenues are more susceptible to fluctuation at News Corp due to a greater concentration on filmed entertainment (both movies and television content) and a lumpy nature given the hit-or-miss proposition of many movie blockbusters.
Gross Margin: News Corp. enjoys a better gross margin than Disney due to less theme park business, which drags down Disney’s margins. This is also reflected in Capital Spending – Disney has much more in order to maintain and grow theme park business.
Operating Margins: News Corp is substantially worse than Disney when it comes to operating margins. This is due in large part to substantial declines in print media (newspaper and magazines), which Disney does not have, and significant expenses at MySpace.
Net Income: The additional expenses noted above from print media and Internet properties also are detrimental to News Corp’s Net income and other earnings figures. Disney substantially outperforms News Corp in these areas.
Operating Cash Flow: Disney relies on strong continuous earnings and steady growth from its established segments and properties. These provide Disney with strong, steady cash flow year after year. In recent years News Corp has seen its respective numbers suffer from declines in traditional media and poor acquisitions.
Profitability
Returns: Once again, Disney’s consistently strong operating results and cash flow result in superior returns on assets and equity. News Corp suffers from much more fluctuation. These figures are often considered the best measurement of company performance as it reflects the company’s ability to best utilize the assets and equity it has at its disposal.
Financial Health ($ in millions)
Working Capital: News Corp has substantially greater liquidity than Disney. Working Capital measures the company’s ability to meet current obligations.
Long-term Debt: In contrast, News Corp. has greater debt than Disney.
Debt/Equity: Given Disney’s greater level of Equity, overall Disney is in greater financial health given its lower reliance on debt.
Valuation
Price/Earnings: Disney has a stronger P/E Ratio in 2009 reflecting investor’s greater confidence in the quality of earnings and the growth potential Disney has over News Corp.
Price/Sales and Price/Book: Similar figures between these companies reflect the fact that investors feel like both these companies are fairly priced.
Time Warner Corporation
Company Overview
Time Warner is a diversified media company that recently spun-off its struggling Internet property AOL. It remains both a developer of content and distributor. Its networks of TBS, TNT and CNN are among the most widely distributed cable networks. Additionally, its HBO channel consistently develops award-winning content. Time Warner’s filmed entertainment business is one of the largest producers of movie and television content and has a massive library of filmed entertainment that can be leveraged on multiple platforms.
Like its publishing peers, Time Warner has struggled in this new age of media distribution. It has popular titles like People and Sports Illustrated, but has not found a long-term solution to profitability for these properties outside of a traditional print product.
With the spin-off of AOL, Time Warner puts behind it one of the worst acquisitions of all time. Additionally, in 2009 it spun-off its cable distribution unit (Time Warner Cable) resulting in a $9 billion dividend. What it chooses to do with that cash reserve remains to be seen. For the immediate future it will focus on its core content business: cable networks, filmed entertainment and magazine publishing.
Financial Highlights and Comparison
Financials ($ in millions)
Revenue: Time Warner’s spin-off of its cable business during early 2009 and AOL in late 2009 served to shrink its top line revenue. However, shedding the AOL property and cable business served to improve its gross margin and operating income in 2009.
Financials: Time Warner for the most part has historically underperformed compared to Disney – dragged down by AOL and its publishing divisions. A number of one-time events make it difficult for a direct comparison between the two companies. Disney has effectively outperformed Time Warner in the recent past, but Time Warner appears to be poised to be more competitive in the future.
Profitability
Returns: Disney’ consistently strong performance lead to a much better return performance than Time Warner. In recent years Disney has done a much better job in providing a return on its assets and equity. Time Warner for the past few years has been dragged down by the ill conceived AOL acquisition.
Other Measures: Again, Disney has consistently outperformed Time Warner with a better utilization of its assets, better margins, and lower debt. In 2009, however, Time Warner made significant changes to improve its competitive potential in future years.
Financial Health ($ in millions)
Working Capital/Long-term Debt: By virtue of the Time Warner Cable spinoff, Time Warner has been able to greatly improve its financial health – through increased cash reserves and lowered debt.
Debt/Equity: Time Warner has a substantially greater equity investment compared to Disney. In comparison to its debt, Time Warner has been significantly more leveraged than Disney – creating an advantage for Disney. Again, Time Warner’s recent actions bring it closer in line with Disney, but for now Disney continues to exhibit greater financial strength.
Valuation
The valuation metrics for both companies show a preference for Disney among investors. There is a greater belief in the consistency of earnings and future growth based upon the greater pricing multiples that Disney’s stock exhibits.
Viacom
Company Overview
Viacom is a global media company with a number of leading cable network channels including MTV, VH1, BET, Nickelodeon, Comedy Central and Spike TV. In 2005, Viacom split from CBS Corp. Viacom has developed a number of Internet properties connected with its cable channels. Additionally, Paramount Pictures produces original filmed content and has a vast archive of films including Titanic and the Godfather properties.
Financial Highlights and Comparison
Financials ($ in millions)
Revenues/Gross Margin: Viacom is a substantially smaller company compared to Disney. Without the extensive publishing and theme park divisions, Viacom is able to generate greater Gross Margins than Disney.
Net Income/Cash Flow: While much smaller than Disney, the quality of Viacom’s earnings compares favorably to Disney.
Profitability
Returns/Margin/Asset Turnover: Viacom results are very similar to Disney’s in certain profitability measurements. It has a comparable net margin and provides a similar return on assets and asset turnover ratio. It provides a substantially better return on equity – however this is a result of a very high level of debt. Viacom’s financial leverage ratio of 3.2 indicates a significantly high level of debt than Disney’s ratio of 1.9.
Financial Health ($ in millions)
Financial Health: As noted above by the financial leverage ratio, Viacom is saddled with substantially more debt than Disney. Each of the financial health indices above indicates as substantially greater reliance on debt by Viacom. Disney is in substantially better financial health with a debt ratio less than half of Viacom’s.
Valuation
P/E Ratio, P/E vs. Market, Price/Sales: Disney outperforms Viacom on each of these measures, indicating the markets confidence in the quality and future potential of its earnings.
Price/Book and Price/Cash Flow: While Viacom’s numbers exceed Disney’s in these areas; it may be an indication of overvaluation or inefficiencies from Viacom’s highly leveraged structure.
Disney vs. Competitors Summary
Financials
Revenues: Disney is the largest company among its peers due to its broad diversification among business segments and global reach.
Gross Margins: Disney’s gross margins are much smaller than its rivals, primarily because of the cost structure of its much more extensive theme park business.
Operating Income/Margin: Disney outperforms its rivals in operating income and margin due to its consistent and steady performance. Historically its rivals have struggled with various operating segments that have dragged down their respective performance. However in the most recent year Viacom in particular seems poised to compete against Disney albeit at a reduced dollar level.
Cash Flow: Disney exhibits stronger consistency than its rivals.
Profitability
Profitability: Disney exhibits substantially greater profitability than News Corp and Time Warner. Disney has good consistency from year to year while News Corp and Time Warner struggle through various changes. Viacom is the one rival that is able to exceed Disney performance in terms of return, net margin and asset turnover. However a comparison in the respective company’s financial leverage ratio points to a heavy reliance and risk in terms of amount of debt maintained.
Financial Health
Working Capital: News Corp and Time Warner both have better working capital positions than Disney, while Viacom has the lowest of the four companies. This indicates a better wherewithal among News Corp and Time Warner to meet immediate obligations.
Debt & Equity: By virtue of recent spin offs, Time Warner has been able to substantially reduce its amount of debt. The other three companies have maintained consistent levels the past two years, with Viacom maintaining the least amount of debt. However, more significant is the amount of equity retained within each company compared to the varying amounts of debt. In that respect, Disney has the lowest Debt/Equity ratio among the group indicating strongest financial health.
Valuation
Valuation: In the most recent year, Disney has the highest P/E ratio of the group. Combined with some of the highest levels among the other price ratios, this indicates a strong consensus among investors that Disney offers the best investment opportunity based on future earnings potential and financial strength.
Conclusion
Disney outperforms its closest competitors financially. Time Warner and News Corp have each struggled with underperforming divisions in recent years. While Disney’s broader base of business segments lead to lower gross margins, it’s more efficient operating expense structure result stronger net earnings. Viacom compares favorably in a number of measures but it is much smaller in size than Disney and is burdened by greater debt. Overall, Disney’s size, low debt and strong, consistent results each year yield better financial performance than its closest competitors.
Industry Averages
Financial ratio analysis and industry financial analysis allow vital comparisons that are not possible when dealing with a single numbers. The insights gained through financial analysis of financial ratios will assist in gaining vital understanding of any given company or industry. Users of financial statements should be careful not to place under confidence in ratios or comparisons. Ratios are simply fractions with numerator and denominator. Adequate detailed disclosure of how the industry ratios are computed is often lacking making it harder to analyze using recommendations of a book and then comparing them with industry ratios. In the end these ratios are simply used to provide additional evidence in the determination of the results of financial decisions that have or are being made.
This chart indicates Disney’s current Financial Condition and which we used to compare the businesses current situation.
Their Debt to Equity Ratio which compares what the business owes (debt) to what it owns (equity), gives us a picture of what proportion of the business's financial commitments are covered by the owners' investment. A ratio below 2:1 is desirable and as you can see their way under the industry average with 0.38 being the average 0.55.
The current Ratio compares current assets to current liabilities which indicates Disneys' ability to pay its bills. A ratio of 2:1 means that you have twice as many current assets, as you do current liabilities. In this category Disney falls below the industry average but is still capable of paying its bills.
Disney’s Quick Ratio as seen in the chart is 1.0 and is also below average but it still maintains certain liquidity. This ratio is seen as the better measure of relative "liquidity" due to the fact that some inventories are not easy to sell. The Quick Ratio is the same as the Current Ratio without including inventory.
When comparing Disney to the industry averages, it seems that Disney is financially established and successful.
Forecasting
Assumptions
In order to determine the Forecasting Assumptions for Walt Disney, one must analyze the condensed financial, balance and cash flow statements. These condensed statements include making assumptions about next period’s sales, NOPAT margin, interest rate on beginning debt and tax rate for the income statement. For the balance statement, this includes making assumptions about ratio of net operating working capital to sales, ratio of net operating long-term assets to the following year’s sales, and the ratio of net debt to capital to estimate the levels of debt and equity needed to finance the estimated amount of assets on the balance sheet. The cash flow statement assumptions include cash flow from operations before working capital investments, cash flow from operations after working capital investments, free cash flow available to debt and equity, and free cash flow available to equity.
Reasonable assumptions can be based on the following trends: sales growth behavior, earnings behavior, return on equity behavior and the behavior of components of ROE. All of these trends are determined from the condensed financial statements and can be found in the attached BAV model. As shown in the table below, in 2008 Disney offered a 6.6% annual sales growth ratio followed by a -4.5% ratio in 2009. As explained in Business Analysis & Valuation: Using Financial Statements, “sales growth rates tend to be “mean-reverting” firms with above-average or below-average rates of sales growth tend to revert over time to a “normal” level (historically in the range of 7 to 9 percent for U.S. firms) within three to ten years” (Palepu 6-3). Consequently we are confident that in the next several years the Sales Growth Behavior will improve for the Disney Corporation in tandem with the strengthening global economy.
Earnings Behavior is likewise a useful determination on which to base future forecast assumptions. As detailed in Business Analysis & Valuation, “Earnings have been shown on average to follow a process that can be approximated by a ‘random walk’ or ‘random walk with drift’. This implies that the prior year’s earnings is a good starting point in considering future earnings potential…For most firms, these most recent changes (quarterly data) tend to be partially repeated in subsequent quarters” (Palepu 6-4). As evident in the below profitability data, the earnings behavior reveals that earnings will continue to decrease over the next quarter but remains relatively close to the prior year’s earnings.
Finally regarding Return on Equity Behavior, prior measures of return on investment are not a useful benchmark for future earnings as one would assume. On the contrary, “the resulting behavior of ROE and other measures of return on investment is characterized as mean-reverting, a pattern similar to that observed for sales growth rates earlier. Firms with above-average or below-average rates of return tend to revert over time to a ‘normal’ level” (Palepu 6-5). As evident in the 10-year historic ROE table for comparable U.S. firms, while ROE has been declining slightly, we believe that the historical evidence justifying our mean-reverting assumptions will cause ROE to increase over the next several years.
While the above financial indicators namely sales growth behavior, earnings behavior, and return on equity behavior all indicate a mild recovery and revenue gain for the Disney Company over the next several years, it is essential to also consider macroeconomic impacts which greatly affect our assumptions. Specifically these assumptions include:
- New additions to the brand and consumer’s forecasted reactions to the brand: Due to Robert A. Iger’s successful takeover of Walt Disney in 2005 and his successful acquisition of animation studio Pixar for $7 billion and of comic book publisher and movie studio Marvel for $4 billion, we see his risky nature and expansion raising consumers’ reactions to the brand over the next several years.
- Forecasted climatic conditions in the following years: Assumed to have a negative impact on sales based to international increase in hurricanes, tsunamis and similar world disasters. Consumers do not travel in times of natural disasters and greatly cut discretionary expenses.
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Rising/decreasing indices of unemployment: According to the Bureau of Labor Statistics, the national unemployment rate held at 9.7 percent in the month of March. The rate is projected to consider decreasing with the coming of spring and is assumed to have been lower in the month of March had it not been for the drastic snowstorms in New England and the mid-eastern states of the United States. The decreasing unemployment rate will slowly help to raise consumer confidence as the effects of the decreasing unemployment rate are felt.
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Global and United States monetary crisis: According to the internationally-reputed Financial Times, the effects of the credit freeze, rising interest rates, collapsing housing prices and slashed family savings will have lasting impacts on the U.S. economy and maintain our forecasts low over the next several years.
- Consumer Price Index: Over the last 12 months, the CPI index has risen 2.1% before seasonal adjustment showing positive signs of low inflation and a stabilizing economy, thus positive impacting our forecasts for the next half-decade.
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Job growth rate: As mentioned above, the unemployment rate held steady at 9.7% in the month of March, and job growth was present, creating 162,000 jobs in total in nonfarm payroll employment; specifically 40,000 positions in temporary help services; 27,000 jobs in healthcare employment; and 17,000 jobs in manufacturing to name the principal industries.
5 Year Time Horizon
Due to our assumptions and taking into consideration variables like previous years indicators trends, (i.e. historical sales), inputs from the marketing management team regarding new additions to the brand, and consumers’ forecasted reactions to the brand itself; Forecasted Climatic conditions in the following years, Rising/ Decreasing Indices of unemployment, Global and U.S. monetary crisis, And analyzing the actual and forecasted 7 US key factors of the economy: Real GDP Growth rate, Inflation rate, Gold value, Oil Prices, unemployment rate, job growth rate, Housing market upraise and finally Retail Growth rate, we see that the economy still has a long way to go to be able to fully recuperate itself for the year 2010 due to the economic conditions; we foresee consumer confidence returning in the brand in year 2011; because of all this we have concluded that the forecasted horizon for the next years is as follows:
Valuation
WACC
Weighted average cost of capital measures the current opportunity cost of capital- what is required return for each dollar lent to the company?
To estimate Disney's (WACC) we need a cost of debt and a cost of equity.
Cost of Debt
Although the cost of debt can be found on the , since Disney relies on several different types of debt, we can make an estimate of the cost of debt by looking at its long-term debt rating (in 2007 they were rated A2 which is an upper medium grade rating). Disney's debt rating corresponds to a debt cost of about 5%. The after-tax cost of debt equals 4.33% multiplied by 65%, or 2.8%.
Cost of Equity
Cost of equity is implicit, so there are several methods for calculating it, including the CAPM. The is a traditional method in which the expected return is a function the presumed risk of the stock as implied by the equity's . A higher beta implies greater risk which, in turn, increases the expected return - and the expected return is the same as the cost of equity. (Expected return is simply the view from the investor's perspective while cost of capital is the same number from the company's perspective.)
Cost of Equity = Risk-Free Rate + (Beta x Equity Premium)
If Disney’s beta is 1.17, and if we take the equity premium to be the same as the T-bonds risk free rate, then by using the CAPM formula, we add 5.8% (a 4.94% equity premium x 1.17 beta) to a risk-free rate of 2.0% for a total estimate for Disney's cost of equity capital of 7.8%.
The Weighted Average Cost of Capital
To calculate the WACC we now need to multiply the cost of debt and equity by their respective proportions of invested capital, and add these results.
On Disney's 2009 balance sheet, long-term debt plus short-term debt plus other liabilities equals $29.383 billion. The market value of the equity (market capitalization) is $70.25 billion. Debt is therefore 29.5% of invested capital and equity is 70.5%.
Now we multiply each type of cost of capital by its respective proportion of total capital and then we add the two weighted costs together to arrive at WACC.
Cost Share of Capital Weighted Cost
2.8% 29.5% = 0.83%
7.8% 70.5% = 5.48%
WACC = 6.31%
The WACC is an Investment Tool used by Securities analysts when valuing and selecting investments. WACC is sometimes used as the applied to future for deriving a business's . It represents the minimum rate of return at which a company produces value for its investors.
In Disney’s case, in 2009 it has a ROE of 9.8% and a WACC of 6.31%. This means that for every dollar the company invests into capital, the company is creating 3 cents of value. Under the equity valuation assumptions, the forecasted ROE is 12.65%, which would mean 6 cents per dollar invested. If on the contrary, the company's return was less than WACC, this would indicate that investors should put their money elsewhere.
The average investor generally does not go through the trouble of calculating WACC yet it serves as a useful reality check for investors when they see it in brokerage analysts' reports.
DCF
Free Cash Flow To Equity is a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment.
FCFE is often used by analysts in an attempt to determine the value of a company. This method of valuation gained popularity as the dividend discount model's usefulness became increasingly questionable. It uses a Discounted Cash Flow based on forecasted Return on Equity. The WACC is also sometimes used as the discount rate to calculate the FCFE.
If the expected rate of return is higher than your required rate of return then stock is undervalued for you. Otherwise, if expected rate of return is lower than your required rate of return then stock is overvalued for you.
In this Disney’s case the forecasted rate of return on equity for 2011 is 12.65%, and the expected rate of return implied by market price of common stock is 9.20%, this means that if we use market price as a basis, then the stock would be undervalued and is a good option to buy.
Discounted Abnormal Earnings & Discounted Abnormal Return on Equity
The Discounted Return is a term used to describe the returns generated by a given security or portfolio over a period of time that is different from the expected rate of return. The expected rate of return is the estimated return based on an asset pricing model, using a long run historical average or multiple valuations.
Disney’s Book-To-Market Ratio, which is used to find the value of a company by comparing the book value of a firm to its market value, is 1.9 indicating that the stock is undervalued. An undervalued stock tends to trade at a lower price. Analysts will usually recommend an undervalued stock with a strong buy rating.
Abnormal Returns are merely a summary of how the actual returns differ from the predicted return. In 2010, Disney has a 3.3% present value of abnormal return on common equity indicating that is higher than the expected rate of return. In Disney’s case, return forecast throughout the following years is positive.
Sustainable Earnings
Sustainable Earnings
Sustainable earnings are those that arise from normal business operations in a "normal" economic environment. A firm’s sustainable growth rate is defined as:
Sustainable growth rate = ROE x (1 – Dividend payout ratio)
This is a rate at which a firm can grow while keeping its profitability and financial policies unchanged. A firm’s return on equity and its dividend payout policy determine the pool of funds available for growth. Results for the Company’s SGR are as follows:
2006 2007 2008 2009
Sustainable Growth Rate 9.0% 13.2% 11.6% 7.9%
By comparing to the Historic Values of Key financial Ratios Table (Source: Financial statement data for al publicly traded U.S. companies between 1987 and 2005), we can tell Disney’s trend is above average since the highest ratio was 8.6% in 2003.
Range of Assumptions
Stock Option Compensation Expense
The Company awards stock options and restricted stock units to a broad-based group of management and creative personnel each year during the second quarter (the Annual Grant). The Company uses a binomial valuation model which takes into account variables such as volatility, dividend yield, and the risk-free interest rate. The binomial valuation model also considers the expected exercise multiple (the multiple of exercise price to grant price at which exercises are expected to occur on average) and the termination rate (the probability of a vested option being cancelled due to the termination of the option holder) in computing the value of the option. Accordingly, the Company believes that the binomial valuation model should produce a fair value that is representative of the value of an employee option.
In fiscal years 2009, 2008, and 2007, the weighted average assumptions used in the options-pricing models were as follows:
Although the initial fair value of stock options is not adjusted after the grant date, changes in the Company’s assumptions may change the value of, and therefore the expense related to, future stock option grants. The assumptions that cause the greatest variation in fair value in the binomial valuation model are the expected volatility and expected exercise multiple. Increases or decreases in either the expected volatility or expected exercise multiple will cause the binomial option value to increase or decrease, respectively.
The volatility assumption considers both historical and implied volatility and may be impacted by the Company’s performance as well as changes in economic and market conditions. See Note 13 to the Consolidated Financial Statements for more detailed information. If the expected volatility of 47% used by the Company during 2009 was increased or decreased by five percentage points (i.e. to 52% or to 42%), the weighted average grant date fair value of our 2009 stock option grants would have increased by 9% or decreased by 7%, respectively.
The expected exercise multiple may be influenced by the Company’s future stock performance, stock price volatility, and employee turnover rates. If the exercise multiple assumption of 1.39 used by the Company during 2009 were increased to 1.6 or decreased to 1.2, the weighted average binomial value of our 2009 stock option grants would have increased by 7% or decreased by 8%, respectively.
Employee Compensation – Retirement Benefits
Key assumptions used for the measurement of pension and postretirement medical plans at the beginning of fiscal 2009 were 7.80% for the discount rate, 7.50% for the rate of return on plan assets, and 5.00% for salary increases. Based on this measurement of plan assets and benefit obligations, pension and postretirement medical costs decreased to approximately $214 million for fiscal 2009 compared to $255 million for fiscal 2008. The decrease in pension and postretirement medical expense was primarily due to an increase in the discount rate used to measure the present value of plan obligations.
The Company remeasured plan assets and benefit obligations at October 3, 2009 in accordance with new guidance on accounting for retirement plans. Key assumptions for the measurement at October 3, 2009 were 5.75% for the discount rate, 7.75% for the rate of return on plan assets, and 4.50% for salary increases. Based on the measurement at October 3, 2009, the Company recorded an increase in unrecognized pension and postretirement medical expense, which totals $2.8 billion ($1.8 billion after-tax) as of October 3, 2009.
Pension and Other Benefit Programs
Net periodic benefit cost is based on assumptions determined at the prior-year end measurement date. Actuarial assumptions, such as the discount rate, long-term rate of return on plan assets and the healthcare cost trend rate, have a significant effect on the amounts reported for net periodic benefit cost as well as the related benefit obligations.
Discount Rate
The assumed discount rate for pension and postretirement medical plans reflects the market rates for high-quality corporate bonds currently available. The Company’s discount rate was determined by considering the average of pension yield curves constructed of a large population of high quality corporate bonds. The resulting discount rate reflects the matching of plan liability cash flows to the yield curves.
Long-term rate of return on plan assets
The long-term rate of return on plan assets represents an estimate of long-term returns on an investment portfolio consisting of a mixture of equities, fixed income and alternative investments. When determining the long-term rate of return on plan assets, the Company considers long-term rates of return on the asset classes (both historical and forecasted) in which the Company expects the pension funds to be invested. The following long-term rates of return by asset class were considered in setting the long-term rate of return on plan assets assumption:
Healthcare cost trend rate
The Company reviews external data and its own historical trends for healthcare costs to determine the healthcare cost trend rates for the postretirement medical benefit plans. For the 2009 actuarial valuation, we assumed an 8.5% annual rate of increase in the per capita cost of covered healthcare claims with the rate decreasing in even increments over ten years until reaching 5.0%.
Sensitivity
A one percentage point (ppt) change in the key assumptions would have had the following effects on the projected benefit obligations as of October 3, 2009 and on cost for fiscal 2010:
Bond Rating
According to Investopedia, a bond rating is a grade given to bonds that indicates their credit quality. Private independent rating services such as Standard & Poor's, Moody's and Fitch provide these evaluations of a bond issuer's financial strength, or it’s the ability to pay a bond's principal and interest in a timely fashion. As Investopedia further explains, Bond ratings are expressed as letters ranging from 'AAA', which is the highest grade, to 'C' ("junk"), which is the lowest grade. Different rating services use the same letter grades, but use various combinations of upper- and lower-case letters to differentiate themselves. Annexed to this document is Moody’s “At-a-Glance” Financials of The Walt Disney Company. In this document, we find that the rating given to Disney is a Long Term Rating of A2 defined by Moody’s as “upper-medium grade", subject to "low credit risk", but that have elements which "present and suggest a susceptibility to impairment over the long term". Moody judges obligations rated A as "upper-medium grade", subject to "low credit risk", but that have elements which "present and suggest a susceptibility to impairment over the long term".
Walt Disney Company Financial Analysis Conclusion
In general, Disney exhibits substantially greater profitability and has good consistency from year to year. Using the financial leverage ratios we can see how the company utilizes their money from debt. There are three ratios to analyze from the balance sheet.
First is Asset to Equity and if we compare it to similar industries, Disney’s financial leverage is low at 1.9, meaning it does not have a substantial amount of debt maintained.
Second, the debt-to-assets ratio measures how much of Disney’s assets are financed though debt. Disney’s ratio is 0.47 which is below 1.0; implying most of Disney’s assets are paid for by equity.
The third ratio is the debt-to-equity ratio. A ratio over one hints at a riskier venture because it includes financing with higher debt levels and a ratio under one denotes higher financing with equity. Disney’s debt-to-equity ratio is 0.38, which suggests that for every dollar Disney gets from shareholders for its assets, Disney gets 38 cents in debt also. Investors do not have worry about creditors going after Disney.
There are also the profitability ratios which consist of net profit margin, return on equity (ROE), and return on assets (ROA). These ratios give investors some insight as to how well a company does at creating profits. The ROE will show how efficiently a company uses its capital. The ROA will show the productivity of its assets.
The net profit margin shows how effective a company is at their cost control. It demonstrates how well a company can turn its revenue into profits. Disney’s net profit margin is 9.15%, which is a good ratio and falls in range with competitors of the same industry.
Disney’s 2009 ROE is 9.8%. Comparing this ROE with other companies in the same industry shows that Disney is in the middle. Some competing companies include New Corp (-13.0%), Time Warner (6.5%), and Viacom (20.5%).
Disney’s 2009 ROA is 5.24%. Comparing this ROA with other companies such as News Corp (-5.8%), Time Warner (2.8%), and Viacom (7.3%), Disney is at the higher end of its competitors. Disney can service its debt because they are a mature company with a well recognized name who still generates revenue. This factor can lead to external funding by a bank or other source to help in the financing its debt.
Disney’s free cash flow for 2009 is 3.3B and has had a net increase in cash balance of (+) 416M in 2009 which has created cash efficiency of their operations and the balance sheet. Even though Disney is in the mature stage of its company life-cycle, it still generates money and positive cash flow allowing reinvesting and paying off debt.
Liquidity is one determinant of a company’s debt capacity and is an insight as to if an asset can be readily turned into cash or if a liability must be repaid in the near future.
Disney’s current ratio is 1.33. Disney has a rather good current ratio which means that they do not lack liquidity and can readily reduce its current assets for cash.
Taking the acid test which reduces inventory from the current ratio it yields 1.12. Any ratio over 1.0 means that the company can readily pay off their current liabilities.
Disney’s working capital is $2,955. Any company that has a positive amount for their working capital is in good shape. The positive value means that Disney can fund their short term liabilities with their assets.
Disney also supplies its investors with dividends. Disney’s dividend yield on yahoo finance is .35. The yield ratio tells an investor how much money they could receive per dollar they invest. The higher the ratio, the more money received. Disney’s dividend payout is 20% according to yahoo finance. The dividend ratio tells a potential investor how well Disney’s revenues support its dividends payouts. Mature companies tend to have higher ratios, which, like Disney, they can afford to pay their investors their current dividend payments.
The price per earnings ratio is 20.8 according to yahoo finance. The high number tells investors that the market has high expectations of the firm’s future of financial health. The actual price per book value is 19 yet the stock value is at 36 which could mean that the stock is over valuated, yet after running the DCF valuation of the equity, we arrive at the same share price of 36, meaning that the discounted value of the stock coincides with the market value, therefore reassuring the stocks actual market value. Furthermore, the current ROE is 9.8%, but the forecasted ROE is 12.6%, which also supports the company’s current and future strength.
Taking into account all the aforementioned data and industry comparisons we conclude that Disney is a strong company which has a solid financial future making it a good and sound investment in the long run.
Endnotes
“Walt Disney SWOT Analysis.” 25 December 2009. 2 April 2010.
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(http://corporate.disney.go.com)
“Walt Disney World [stock data].” Morningstar 2010. 1 April 2010, trailing 12 month figures. 1 April 2010. <>.
“Walt Disney World [stock data].” Morningstar 2010. 1 April 2010. 1 April 2010. <>.
“Respective Companies [stock data].” Morningstar 2010. 1 April 2010. <>.
Palepu, Krishna G. and Paul M. Healy. Business Analysis & Valuation: Using Financial Statements. Mason, OH: 2008.