Please note this is not a rumor that Disney is building another theme park, only an analysis of Disney’s Parks & Resorts (P&R) financial data, suggesting that Disney needs to construct another Walt Disney World (WDW) theme park by the mid-2020s in order to maintain healthy growth within P&R.
The Good
P&R Gross Margin:
After over a decade of subpar financial performance, Disney’s domestic theme parks are once again at former levels of profitability.
For the 2014 fiscal year, P&R gross margin finished at
17.6%, up from 15.8% the year before, and up more than 5% since cratering in 2010. This was the segment’s best margin since 2002.
Even better, excluding the abysmal performance at Disneyland Paris (DLP), P&R gross margin was
20.4%.
Historical context is needed in order to appreciate this number.
P&R gross margin averaged 18.8% from fiscal years 1972 to 1984 (i.e. the first years of WDW operation) and 22.2% from fiscal years 1985 to 2005 (i.e. the Michael Eisner years). Excluding the current year, this number has averaged a disappointing 14.7% under CEO Bob Iger.
This year’s 20.4% (excluding DLP) represents a return to normalcy.
It appears the years of me badmouthing P&R margins are over.
Purists might dislike what’s happening at the theme parks but, after 5 years, P&R Chairman Tom Staggs and his team have corrected most of the financial problems created by former P&R Chairmen Paul Pressler and Jay Rasulo.
It’s not all sunshine and roses though.
This year’s improved margin was the result of a 5.3%
decrease in P&R selling, general, administrative and other expenses that was “due to the absence of development costs for MyMagic+”. In other words, if Disney hadn’t thrown away so much in previous years on “information technology spending related to MyMagic+”, margins would have improved years ago.
If you read stories about MyMagic+ cost overruns and disappointing financial results, it’s because they are true.
As Disney has warned, much of the IT used for MyMagic+ is becoming obsolete much more rapidly than other traditional P&R investments, meaning Disney will need to pump even more money into MyMagic+ in the not-too-distant future. In the coming years, this could once again threaten P&R’s improved margin.
There’s a lesson to be learned here. Sometimes depreciating the cost of a brick & mortar theme park attraction over 25-to-40 years is better for profitability than investing in the latest whiz-bang technology with its accelerated depreciation and obsolescence.
Theme Park Attendance:
Domestic attendance was up
4% for quarter and
3% for the year. Coupled with last year’s 4% gain, Disney hasn’t seen this kind of improvement since 2005/2006.
With the Magic Kingdom’s (MK) hub redesign and new bus terminal, a third track at Toy Story Mania (TSM), and a third theater at Soarin’ in the planning phases, Disney is taking the right steps to alleviate WDW overcrowding.
More is needed.
WDW attendance is up 10 million since Disney’s Animal Kingdom (DAK) opened in 1998 and can be expected to grow further once new lands are unveiled in DAK and Disney’s Hollywood Studios (DHS). WDW needs new attractions, new lands, and (gasp) perhaps even a 5th Gate to handle the increased attendance.
The Bad
There are some worrisome trends, which if left unattended, will cause Disney heartache down the road.
P&R Revenue:
Revenue grew by only
7.2% in 2014, the worst ever in a non-recession year. However, this number was pulled down by DLP, where revenue declined by €30 million. Domestically, P&R revenue was a slightly more respectable
8.2%, the worst in 4 years.
More worrisome than this year’s number is the long-term trend under Iger.
In 9 years, Iger has generated a compound growth rate of only 5.9% annually. For comparison, Eisner generated 10.6% annually, even more impressive considering he maintained this growth rate for over 2 decades. 5.9% is not good, especially when that growth is overwhelmingly the result of higher prices. Add in an 18% domestic theme park attendance increase since Iger took charge, and 5.9% is downright weak.
Record attendance coupled with record prices will result in record revenue. The question is what happens if Disney doesn’t take the steps necessary to keep generating record attendance.
To date, Iger’s revenue growth has come at the expense of ‘Guests’, who pay more for less as Disney has focused on higher prices and cost cuts rather than growing the business organically to improve margins. A business can’t thrive on price increases alone.
In order to achieve sustainable growth, Disney needs to grow revenue by reinvesting in its theme parks, particularly WDW, which represents over half of P&R’s revenue. Disney needs to give consumers genuine reasons to spend more in Orlando.
WDW Investments:
Yes, yes, WDW will add more years from now. However,
right now, domestic P&R capital expenditure (capex) finished at
9.6% for the year, one of Disney’s lowest ever. Domestic capex was only 10.0% last year. For comparison, Eisner averaged 18.8% over 21 years while Iger averaged 14.3% for his first 7 years.
We read stories about great things coming to WDW. However, Disney is not spending domestically right now.
Talking about building is not the same as actually building.
This “check is in the mail” routine is beginning to wear thin.
The Ugly
Domestic hotel occupancy:
What? Occupancy was up
4% summer-to-summer and year-to-year. How can that possibly be ugly?
With the opening of Seven Dwarfs Mine Train (SDMT), the
Frozen tie-ins, and Diagon Alley, this was a record summer in Orlando.
Even with its new offerings, Universal is no more than a 3-day stop for most, meaning WDW benefited from Uni’s investment. SDMT and
Frozen proved to be popular at the theme parks. The domestic economy was on an uptick while International visitors still accounted for
22% of WDW attendance despite weak overseas markets. This was a blockbuster summer in Orlando.
Except when adding an entire new theme park, the last couple of years is as good as it gets. Disney should have reported knock-your-socks-off occupancy numbers this summer.
Instead, WDW managed a measly
83% occupancy. It actually was
down 3% from 2 quarters ago when MyMagic+ was an onsite-only perk.
Think about that for a moment. Orlando had a great summer and WDW had record attendance, yet Disney managed only 83%.
Take into consideration WDW’s timeshares along with the 5% of rooms that currently are out-of-service, and WDW’s hotel occupancy was
lower than Metro Orlando hotels, much lower than the nearby Buena Vista hotels.
WDW hotel prices are just too darned high.
Domestic Per Room Guest Spending (PRGS) was up
5% for the quarter and for the year. With so many “numbers guys” running the theme parks, Disney is going to do everything it can keep that metric climbing. Instead of lowering WDW hotel prices, Disney will look to convert existing rooms into DVC.
Because of the way DVC rooms are counted, this conversion will appear to improve both PRGS and occupancy rates, even if total annual revenue collected at the hotels remains relatively flat. It’s a strategy focused on specific metrics rather than overall results, as Disney looks to free up hotel capital for “re-investment” in its next
$6.5 billion (the amount spent in 2014) in stock buybacks.
Meanwhile, Disney continues to partner with other hotel chains to provide pseudo-onsite accommodations. Rather than build, Iger clearly would rather have someone else invest the capital. Hey, Iger’s compensation package is tied to return on invested capital, so it’s understandable why Iger wants someone else footing the bill, even if it means less cash for Disney.
Unless you become a DVC member, expect to pay sky-high prices for onsite stays as existing WDW hotel rooms slowly disappear.
Theme Park Spending:
It can be a bad sign when a company changes how it reports a well-established metric. Disney has reported “
Parks and Resorts Merchandise, food and beverage” sales
for decades.
Until now.
For the first time ever, Disney is reporting “
Retail merchandise, food and beverage” sales rather than separate P&R sales. In other words, Disney is tucking retail sales in with theme park sales. With retail sales outside of the theme parks up
11.2% for the year (thank you
Frozen), Disney is trying to hide lagging theme park sales behind strong retail sales.
Last year, Disney reported
2013 merchandise, food and beverage sales of $4.189 billion. This year, like magic, Disney reported the same
2013 number as $5.185 billion. Poof, a little accounting hocus-pocus and merchandise revenue is up an extra $1 billion.
As I posted months ago (
see the link here), Disney’s recent aggressive price increases have hurt theme park merchandise, food, and beverage sales. Increases at the theme parks have caused ‘Guests’ to alter their spending patterns, resulting in fewer units sold as prices outpace income.
Under Eisner, theme park merchandise, food and beverage sales typically beat admission sales by 3%. In other words, for every $1 in ticket sales, Disney sold $1.03 in merchandise, food, and beverage at the theme parks.
In just the last few years, aggressive price increases have wreaked havoc on this ratio. Last year, theme park merchandise, food, and beverage sales were actually 11%
lower than ticket sales.
The disparity continues to widen as merchandise, food, and beverage sales lag further behind ticket sales, hence the need to redefine this metric, making it appear as if merchandise, food, and beverage sales are just peachy.
Higher prices at the theme parks are hurting sales.
Disney needs to find a way to grow P&R revenue other than constant price increases.
What Does It All Mean?
Whether you like what’s happening at the theme parks or not, Disney’s domestic P&R operations are once again performing at old
financial levels. Margin is back to where it should be.
Future improvements in profitability through quality cuts will become increasingly difficult. Disney has cut out fat and now is cutting bone.
Furthermore, there are growing signs that Disney’s aggressive price increases are altering the way guests spend at the resorts. Hotel occupancy is weak despite record attendance while merchandise, food, and beverage sales are lagging.
There are only so many pennies that can be squeezed out of 'Guests'. Only so much can be done with show cuts and higher prices. After years of both of these, ‘Guests’ are beginning to revolt.
Paraphrasing what Princess Leah once said, “The more you tighten your grip, Iger, the more Guest spending will slip through your fingers.”
Currently, P&R is financially sound but is headed towards dangerous waters. The challenge facing Disney is charting a course towards sustainable growth. The current direction of quality cuts and higher prices is the wrong heading.
With WDW generating more than half of P&R revenue, any path to meaningful growth begins in Orlando. That means building, a lot of building.
New lands at DAK and DHS will help but they are not enough. If Disney wants to sustain WDW’s long-term average annual attendance increase of 2% (and its associated operating income growth), then Disney needs to take steps to make sure there is capacity for another 10 million gate clicks by 2024.
With Disney’s Orlando business financially robust and WDW’s existing theme parks bursting at the seams, it’s time for Disney to start planning for a 5th Gate.
