Fitch Affirms Disney's IDR at 'A'; Outlook Stable
KEY RATING DRIVERS
Significant Financial Flexibility: Disney's operating profile positions the company to generate free cash flow (FCF) in excess of \\$3.5 billion annually during the ratings horizon, which coupled with strong liquidity and solid credit metrics provides the company with considerable financial flexibility at the current ratings. Disney's investment cycle within its Parks and Resorts segment is expected to increase capital spending to approximately \\$5 billion during fiscal 2016, which will temporarily hamper FCF generation.
Consistent Financial Policy: Given the strength of Disney's underlying businesses, strong liquidity position and Fitch's FCF expectations, Disney has the financial flexibility to accommodate a higher level of share repurchases, which are expected to range between \\$6 billion and \\$8 billion during fiscal 2016, in a manner consistent with its current ratings. Ratings incorporate Fitch's expectations that the company's share repurchases and M&A activity will likely exceed FCF generation given strong liquidity and the current credit profile.
Leading Market Positions and Leveragability: Disney has a very consistent investment strategy centered on creating or acquiring intellectual property and content that is leverageable across Disney's various platforms. Disney is uniquely positioned, relative to its peers, to capitalize and monetize its internally or externally developed franchises and brands, which in turn strengthens the company's operating and credit profile and provides Disney with a sustainable competitive advantage.
Strength of Cable Networks: Disney's strong portfolio of cable networks, ESPN in particular, underlies the company's ratings. Fitch Ratings believes that the top-tier channels will continue to be a must carry for the distributors and are likely to retain pricing power. Disney's operating profile benefits from the stability, recurring dual-stream revenue profile, high operating margin and FCF generation characteristics attributable to its cable network business. Fitch expects this segment will continue to generate a significant amount of Disney's cash flow.
Credible Strategy to Address Threats: Disney's strong asset portfolio positions the company to address the secular threats and opportunities presented by emerging alternative distribution platforms and continued audience fragmentation across the media and entertainment landscape.
Overall the ratings reflect the company's leading market positions within its core businesses. Further, Disney has a very consistent investment strategy that is centered on creating or acquiring intellectual property and content that is leverageable across its various platforms (cable and broadcast network, studio, parks and resorts, and consumer products).
Disney's operating profile positions the company to generate meaningful levels of FCF (defined as cash flow from operations less capital expenditures and dividends), providing the company with considerable financial flexibility at the current ratings. Disney's investment cycle within its Parks and Resort segment is expected to increase capital spending to approximately \\$5 billion during fiscal 2016, which will temporarily hamper FCF generation during fiscal 2016. Fitch anticipates that Disney will generate in excess of \\$3.5 billion of annual FCF during the ratings horizon.
Disney's strong portfolio of cable networks underlies the company's ratings, and its operating profile continues to benefit from the stable, recurring dual-stream revenue profile and high operating margin characteristics attributable to its cable network business. Fitch believes there is sufficient flexibility within the current ratings to accommodate slower affiliate fee revenue and operating income growth within this business.
Disney's cable networks generate the largest portion of total revenue and EBITDA, resulting in incremental stability in the total revenue and FCF profile. Secular issues such as the stagnant multi-channel video subscriber base and its effect on affiliate fee revenue, rising programming costs, particularly sports programming, the impact of foreign exchange, and Disney's ability to pass the higher costs on to multi-channel video programming distributors (MVPDs) will remain a significant risk to the company's operating profile. However, Fitch believes that Disney is in a strong position to retain pricing power going forward, as its collection of top-tier cable networks continue to command audience and ratings and be a must-carry for the MVPDs. In addition, Disney has, in large part, successfully matched the tenor of its long-term sports programming rights with the terms of its various affiliation agreements with the MVPDs.
Ratings incorporate the cyclicality of the company's businesses, particularly Parks & Resorts (30% of Disney's revenue through the LTM Jan. 2, 2016), Consumer Products & Interactive Media, and the advertising portion of broadcast and cable networks (16%). Should macroeconomic volatility return, Fitch expects these cyclical businesses to be under renewed pressure but that the company's credit and financial profile will likely remain within expectations for the current ratings.
Disney is well positioned to address the secular threats and opportunities presented by emerging alternative distribution platforms and continued audience fragmentation across the media and entertainment landscape. The evolving media landscape, including the growing prominence of Internet-based and time shifted television content, will not have a material negative impact on Disney's credit profile or FCF over the intermediate term. Further, in Fitch's view, the proliferation of new over-the-top entrants and methods of consumption will continue to drive more demand for Disney's content. As to the uncertainty around the continued ability of cable networks to pass increased programming costs on to the distributors, Fitch believes it poses moderate risk to cable network providers over the longer term. Mitigants for Disney include Fitch's belief that the top-tier channels will retain leverage with distributors going forward.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case include:
--The revenue growth within the company's cable networks business (Disney's Media Networks segment) reflects the stability of the business and expected affiliate fee increases. Fitch anticipates mid-single-digit affiliate revenue growth.
--Disney's broadcasting business benefits from a stable economic and advertising environment while incorporating typical political advertising revenue cycle. Additionally this segment will benefit from growing retransmission consent fees. Revenue growth ranges between 2% during non-political years and 4% during political years.
--Programming expenses are expected to increase by high-single digits driven by sports rights costs.
--Fitch assumes typical volatility within the Studio Entertainment, Parks and Resort, and Consumer Products & Interactive Media operating segments.
--Domestic revenues grow faster than International revenues within the company's Parks and Resort segment. Fitch incorporates start-up expenses related to the opening of its Shanghai Disney Resort in 2016.
--Fitch expects low double digit growth within Disney's Studio Entertainment segment this year due to the release of Star Wars and a strong 2016 film slate. Theatrical revenues are slightly offset by a weaker Home Video release schedule when compared to 2015. Home entertainment revenues will track the theatrical success in 2017 and 2018. Television and SVOD revenues grow at a mid-single digit pace while home entertainment revenues remain flat.
--From a margin perspective, the base case assumes relatively flat margins within the company's Media Networks segment as retransmission revenue gains enhance broadcast margins while cable network margins remain stable reflecting the company's ability to grow higher margin affiliate fee revenues at a similar pace to increasing programming costs. Disney's pre-opening expenses related to its Shanghai Disneyland opening are expected to be offset by strong domestic operating performance leading to relatively flat margins within the company's Parks and Resorts segment. Coming off a strong operating performance in fiscal 2015, margins within Studio Entertainment are expected to contract somewhat during fiscal 2016.
LEVERAGE AND FINANCIAL POLICY
Fitch does not anticipate any meaningful changes to Disney's financial policy over the ratings horizon. Fitch believes Disney maintains an appropriate balance between returning capital to shareholders, in the form of dividends and share repurchases, and investing in the strategic needs of its business. In terms of capital allocation priority, Fitch believes investing in internal opportunities focused on organic growth, such as the company's investment in its various parks and resorts worldwide and long term sports rights deals, takes precedence over merger and acquisitions and shareholder returns.
Disney's capital structure and credit protection metrics remain consistent and within Fitch's expectations for the current rating. Consolidated leverage of 1.1x as of the latest 12 months (LTM) period ended Jan. 2, 2016, is in line with fiscal year-end 2015 and 2014 metrics. Going forward, Fitch believes leverage will range between 1x and 1.4x during the ratings horizon after consideration for a modest increase in debt levels related to the higher level of share repurchases.
SHAREHOLDER RETURNS
Fitch expects that Disney will manage the level of share repurchase activity in a manner consistent with its current ratings and acknowledges that the company's share repurchases and M&A activity will likely exceed FCF generation. Fitch anticipates share repurchases to range between \\$6 billion and \\$8 billion during fiscal 2016. Disney repurchased approximately 21.2 million shares of its common stock for approximately \\$2.4 billion during its first quarter of fiscal 2016. As of Jan. 2, 2016, the company had remaining authorization to repurchase approximately 334 million additional shares.
RATING SENSITIVITIES
Positive: Upward momentum to the ratings is unlikely over the intermediate term. However, a compelling rationale for, and an explicit public commitment to, more conservative leverage thresholds could result in upgrade consideration.
Negative: Negative rating actions are more likely to coincide with discretionary actions of Disney's management rather than by operating performance, reflecting the company's significant financial flexibility. Decisions that increase leverage beyond 1.75x in the absence of a credible plan to reduce leverage will likely lead to a negative rating action.
LIQUIDITY
Disney's liquidity position and financial flexibility remain strong and is supported by significant FCF generation as well as \\$6 billion of aggregate available borrowing capacity (as of Jan. 2, 2016) under three credit facilities. Commitments under these credit facilities support the company's \\$6 billion CP program and expire during March 2017 (\\$1.5 billion), March 2019 (\\$2.25 billion) and March 2021 (\\$2.25 billion). In addition, the company had approximately \\$4.3 billion of cash on hand as of Jan. 2, 2016. Scheduled maturities are well laddered and manageable considering FCF generation expectations and access to capital markets.
Disney has approximately \\$2 billion of debt that isscheduled to mature during fiscal 2016 (\\$500 matured during Dec. 2015) followed by \\$2.2 billion and \\$1.8 billion during fiscal 2017 and 2018 respectively. Fitch does not expect debt reduction going forward.
FULL LIST OF RATING ACTIONS
Total debt as of Jan. 2, 2016 was approximately \\$18.9 billion and consisted of:
--\\$4.3 billion of commercial paper (CP);
--\\$13.4 billion of notes and debentures, with maturities ranging from February 2016 - 2093;
--\\$532 million of debt related to international theme parks, which is non-recourse back to Disney but which Fitch consolidates under the assumption that the company would back the loan payments;
--Approximately \\$667 million of foreign currency-denominated debt (as of FYE15), including the debt related to the acquisition of UTV.
Fitch affirms Disney's ratings as follows:
The Walt Disney Company
--IDR at 'A';
--Senior unsecured debt at 'A';
--Senior unsecured revolvers at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
ABC Inc.
--IDR at 'A';
--Senior unsecured debt at 'A'.
Disney Enterprises, Inc.
--IDR at 'A';
--Senior unsecured debt at 'A'.
Fitch links the IDRs of the issuing entities (predominantly based on the lack of any material restrictions on movements of cash between the entities) and treats the unsecured debt of the entire company as pari passu. Fitch recognizes the absence of upstream guarantees from the operating assets and that debt at Disney Enterprises is structurally senior to the holding company debt. However, Fitch does not distinguish the issue ratings at the two entities due to the strong 'A' category-investment grade IDR, Fitch's expectations of stable financial policies and the anticipation that future debt will be issued by Walt Disney Company. Fitch would consider distinguishing between the ratings if it perceived heightened risk of the company's IDR falling to non-investment grade (where Disney Enterprises' enhanced recovery prospects would be more relevant).
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