Disney is on top of its small world, but not everyone is along for the ride


The Magic Kingdom has lost some of its Wall Street magic. MShares of Disney have held up better in this turbulent year than those of any of its peers. Investors have lauded a strong management team and solid business strategies and execution for keeping the company shielded from recession woes longer than other media biggies.

But now, a growing chorus of Wall Street observers argues that Disney's stock trades at too much of a premium to its sector peers, especially given recent reductions to earnings estimates.

In other words, it might be too expensive compared with its sector rivals, especially in a recession economy.

Last week, for example, Pali Research analyst Rich Greenfield downgraded shares from "buy" to "neutral."

"While Disney has long traded at premium earnings and free-cash-flow multiples to its large-cap media peers, its valuation gap has meaningfully widened over the past month to a level that we can't ignore," he said in a report.

Greenfield reduced his earnings estimates for Disney on Nov. 18, when the conglomerate's stock traded at a 2009 price/earnings multiple of 10.4 times and a free-cash-flow multiple of 11.7 times.

In issuing his downgrade, the Pali analyst highlighted that Disney was trading at a price/earnings multiple of 13.1 times, compared with Viacom's eight times and News Corp.'s nine times multiples. Meanwhile, Disney's free-cash-flow multiple had ballooned to 15 times, well ahead of Viacom's seven and News Corp.'s eight.

Greenfield argued that the gap is too big, though he acknowledged that "Disney deserves a premium multiple to News Corp. given its superior asset mix and to Viacom given the higher quality of its cable network assets."

Also last week, Sanford C. Bernstein analyst Michael Nathanson highlighted recent signs of declining momentum at several Disney units, including its TV networks and theme parks.

"In stark contrast to business trends, Disney's relative price/earnings multiple has ballooned to a 13% premium to the broader market, and Disney currently trades 41 relative multiple points above its media conglomerate peers — the widest margin in recent history," he wrote in a report titled "Can the Disney Difference Be This Wide?"

His conclusion: "While we believe that Disney should trade at a premium to other media conglomerates due to the strength of management and the competitive positioning of its businesses, we also do not believe that the current gap relative to its peers is justified. Either the stock trades down or peers need to trade up."

Nathanson also pointed out that Disney shares haven't come under the same type of pressure as peers given recent earnings downgrades from analysts. "Since the end of October, fiscal-year 2009 consensus earnings-per-share estimates for Disney have been cut by 8%, and yet the stock has underperformed the S&P 500 by only 1%."

Nathanson rates Disney shares "market-perform" with a price target of $22, 7.5% below the price Tuesday.

Finally, Barclays Capital analyst Anthony DiClemente on Friday reduced his film estimates for Disney. "In addition to headwinds for advertising and theme parks, Disney's creative cycle could exacerbate year-over-year earnings-per-share declines in fiscal-year 2009," he wrote.

DiClemente, too, pointed out the Disney valuation edge, predicting that it would underperform during the next six to nine months. "Disney trades at a 50%-plus premium to its peers, though it may have the most downside to Street consensus in the group," he said in maintaining an "underweight" rating.

While Disney's appeal has faded recently, the downbeaten stocks of other media giants have attracted more attention.

Greenfield likes Viacom, which has struggled with cable network ad trends, and News Corp., whose local TV stations have been hit hard by the recession. He rates both a "buy."

In speaking out for Viacom's stock, he said investor fears regarding possible additional stock sales by the Viacom chairman are overdone. "While investors may fear that Sumner Redstone's National Amusements will need to sell Viacom shares in the near future, we find it impossible to not want to own Viacom shares at 6.6 times trough earnings," Greenfield wrote, predicting the stock could hit $25 in 2009.

Wall Street also has looked at Time Warner with bullishness. For example, UBS analyst Michael Morris last month reiterated his "buy" rating, arguing that "shares do not fully reflect the true value of the company's assets."

Citi Investment Research analyst Jason Bazinet reiterated that TW remains his top pick for 2009.

"Although several media stocks look oversold at these levels, TW still stands out as the one stock with imminent structural catalysts," he said. He holds a "buy" rating on TW's stock, with a $19 target price.

Georg Szalai can be reached at georg.szalai@THR.com.