Disney Credit Rating Lowered

S&P cites a more gradual earnings recovery than management's previous guidance had indicated

On Oct. 4, 2002, Standard & Poor's lowered its long-term credit ratings on Walt Disney Co. (DIS ) based on expectations that credit measures will remain weak for the rating as earnings recover more gradually than management's previous guidance had indicated. The company's corporate credit rating was lowered to 'BBB+' from 'A-'.

The ratings were removed from CreditWatch where they were placed with negative implications on Aug. 2, 2002, when management had lowered its guidance for the fiscal 2002 fourth quarter. The 'A-2' short-term corporate credit rating, which was not on CreditWatch, was affirmed.

Burbank, Calif.-based Disney is a broad-based entertainment company with theme parks and resorts, cable and free TV broadcasting, character licensing and studio store retailing. Disney had $13.1 billion in net debt as of June 30, 2002.

In the first nine months of its fiscal year ended Sept. 30, 2002, debt declined 9% (pro forma for the Fox Family Worldwide acquisition) while EBITDA fell 28%. Net debt to trailing cash flow has risen from 3.1 times (x) pro forma for the fiscal year ended Sept. 30, 2001 to 3.7x at June 30, 2002.

Earnings pressures have been economy and travel security-related, as well as related to Disney's competitive position in broadcasting and filmed entertainment. Theme parks and resorts continue to reflect lower attendance from higher-spending international visitors and a heavier reliance on lower-spending local attendees. Media network pressures are linked to lower ratings at the ABC television network and TV stations, increased sports costs, and slowly recovering radio advertising activity. The consumer products group has been in an extended process of restructuring licenses and refurbishing stores. Filmed entertainment has scored recent successes on the heels of mid-summer write-offs.

Management's earnings guidance now targets double-digit EBITDA growth for fiscal 2003, although the second half of the year is likely to exhibit stronger growth than the first half. Achieving guidance will depend on increased confidence in travel security at the parks and resorts. The ABC Network will rely on a sustained moderate recovery of ad demand and prospects of improving ratings, rather than on significant programming or other cost cuts. Consumer products' performance results will hinge on consumer spending levels and the appeal of Disney licensed products.

Despite lower capital spending trends in the current fiscal year, free cash flow is expected to be lower for fiscal 2002, and Standard & Poor's believes it may not recover dramatically until fiscal 2004. The common dividend, subject to board approval, is likely to limit debt reduction for fiscal 2003. A stronger recovery in fiscal 2004 still could be muted by economic and security factors, as well as the characteristic unpredictability of the entertainment content businesses. Recent indications that management may sell certain non-strategic assets could support the rating if they transpire.

Other positive considerations include a currently good ad demand environment, the trend of growth in DVD sales, operating cost reductions, careful cash flow management, and good liquidity.

Disney's liquid resources include about $4.5 billion in untapped credit lines, consisting of a $2.25 billion revolving credit for commercial paper backup, expiring in 2005 and a $2.25 billion 364-day facility with a one-year extension option. Very low interest rates have helped maintain strong EBITDA to interest coverage and ample compliance with a 3.0x interest coverage covenant in its long-term facility.

Disney's liquid resources, together with discretionary cash flow, should more than cover the next two years' debt maturities, although continued refinancing is expected. The company's cushion of covenant compliance is substantial. Modest-sized contingent obligations could arise with this rating action, which can easily be accommodated by the company's credit facilities. However, Disney's maturity profile continues to be heavily front-loaded, with nearly 30%, or about $4.4 billion of its non-commercial paper debt obligations coming due over the next two years. Deviation of operating performance and cash flow generation below management's expectations would reduce the relatively comfortable margin the company should have in meeting maturities.

The company's more active consideration of asset sales could augment its cushion of liquidity. Maintaining operating performance and liquidity are crucial to the ongoing advantageous interest costs the company has traditionally enjoyed.

The outlook is stable. Earnings visibility is likely to remain clouded by economic and security factors, as well as the unpredictable nature of entertainment content. However, potential asset sales represent a good source of additional liquidity. Standard & Poor's believes a target gross debt to cash flow ratio of 3.0x is appropriate for Disney at the 'BBB+' level, and that this should be achieved over the next one-to-two years. The outlook further reflects Standard & Poor's assumption that the company will move to refinance its upcoming maturities.

From Standard & Poor's CreditWire

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