Disney Downgrade = Ouch! (but is it right?)

I suppose it was bound to happen sooner or later.  If you've been reading this blog much at all (and granted I've only been posting for a month, so if you've read it at all, Thanks!), I've been focusing a good deal of articles to the larger macro-economic environment that TWDC faces and what the company 'appears' to be doing about it. 

Granted it's from a decidedly more business based look (despite my technology love and hope to be an Imagineer someday, I have a business background and interest as well), which can be bland reading sometimes I admit.  But I'm doing my best to keep it light and relevant. 

In the past several weeks, we've touched on some interesting financial topics:

• We talked about PI closing because of it not really equating to, as the real estate guys like to call it, its current 'highest and best use'.  An idea that Jim Hill's post today, among many others, corroborates well I think.
• We talked about Bob Iger and CFO Tom Staggs' work with Wall Street to try and paint TWDC as a different animal viz-a-viz other entertainment companies.
• We talked about what Bob Iger and others in the company seem to be up to on the digital media front.
• We had a discussion about Disney's debt position, to a certain extent.
• I noted a really good article by Kevin Yee about the toll that high oil could take on the parks.
• We talked about the increasing profitability of the now Disney Internet Media Group.

So today an analyst at Lehman Brothers downgraded Disney based on something very close to taking the general negative view on all of these.  Which is a real kick in the shins for Disney stock holders since the stock is already down $5 a share since mid-May (that's about a 15% loss in the last 6 weeks). 

He also cut his 2009 projected earnings from $2.56 a share to $2.25 a share.  That $.31 a share difference for the ENTIRE projected 2009 operating year (Oct 1, 2008 through Sept 30, 2009) amounts to almost a $600 million dollar drop in projected earnings.  That means he expects the WHOLE company to earn LESS than it did in FY 2007.  

I'm not sure I agree with all the reasoning that the analyst gave for the downgrade however.  We've established that the companies cash to debt situation has improved, that DIMG is making money, that there is plenty of money in the bank and so far they are no where close to tapping out their credit facilities.  The Studio is making good movies (and presumably money) as are the other parts of the company such as Consumer Products, etc.

Beyond that, company executives only have so many ways to increase bottom line revenues in an increasingly tough macro-economic environment like this one is shaping up to be. 

If you can't raise prices or sell more then the next fastest way to increased net profit typically is through cost control (discounting discounts of course, if they work). 

Cost control measures tend to use lagging measures however and often it is easy to overshoot your mark.  So you have to be careful.  When times are good and your pulling in gobs of money, you do your best to keep costs inline, but grabbing cash/market share/etc. is first and foremost.  When times are getting tough, companies start tightening early (layoffs or slowing hiring, cutting back overhead costs, etc.).  It's very easy to overshoot, but not know it until you can't do much about it.  It's certainly NOT an exact science.

As Jim Hill and Kevin both point out in some of their articles, Disney is doing their part to contain and lower costs, while increasing profitability of other entertainment categories where they can like re-doing PI.  I think they will continue to do that slowly for a while, though to you and I it won't seem slowly but rather acute.  We'll feel like we are losing LOTS of things at a pretty steady clip, but that's just good management folks.

We'll have to wait till the end of the month to see how the 3rd quarter did for the company.  Frankly I don't expect to see anything different at this stage from what we've been seeing previously.  Likewise, I wouldn't expect much change even through the end of the fiscal year.  Those vacations are already on the books and mostly paid for, the movies are already in the can and presumably costed on the books, consumer products is WELL into Christmas planning already, and I don't think much will change right away for ESPN or ABC.

Only Disney will know the forward looking projections based on bookings, turnstile numbers, screen revenues, etc.  And guys like you and I will only find out if they are truly worried when they start talking about next years projected earnings.

The stock is taking a short term beating for sure, but I'm not ready to throw the towel in yet on the companies long term prospects.