Giant media company Walt Disney (NYSE:DIS) is due to report Q1 2016 earnings on Feb. 9^th 2016 after market close. Wall Street expects Disney to report revenue of $14.75B, good for 10.1% Y/Y growth with diluted EPS of $1.45, good for 14.2% Y/Y growth. Walt Disney did not provide specific guidance for Q1 2016 but only provided highlights of how it expects costs for its various segments to trend during 2016. Meanwhile, it’s worth noting that Walt Disney has exceeded consensus earnings estimates in the last four consecutive quarters.

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Walt Disney Earnings Surprise History

Source: NASDAQ

Battleground stock

There is an earnings whisper that Walt Disney will surpass Wall Street expectations by reporting an EPS of $1.48. But it’s doubtful whether this will be enough to give much forward momentum to Disney stock. Walt Disney stock has become a battleground stock for investors, with the bulls counting on the company’s flamboyant films and theme parks to take the stock higher while the bears carp about weaknesses in the company’s cable networks, particularly ESPN, due to cord-cutting. Disney stock has consistently featured among the five most shorted stocks on the Dow Jones. The stock is down 11.4% YTD partly due to broader market weakness and partly due to the said cable weakness. The stock has been selling off heading into its earnings call, an indication of the general pessimism hanging around the company.

Walt Disney Stock YTD Returns

Source: Disney stock price chart by amigobulls.com

Lately, it's Walt Disney bulls who have been having the last laugh after the company’s quarterly earnings calls. During the last quarter, Disney’s Media Networks performed beyond expectations accounting for 44% of the company’s revenue and an even bigger 53% of operating income. The segment’s ad revenue grew 8% when you exclude the benefit of the 53^rdweek and 17% when you include it. ESPN ad revenue was up 5%, which appears surprising given that Gartner estimates that ESPN subscribers fell from 97M in 2013 to 92M in 2015.

But one thing that Disney bears have often been neglecting is the fact that ESPN remains the most popular cable sports channel by a wide margin. While that does not completely inure it from industrywide cord-cutting, it does help Disney to increase its cable affiliate fees at a rate that exceeds revenue loss due to churn. Disney had this to say about the popularity of ESPN during the last earnings call:

In fiscal 2015, ESPN was the number one full-time cable network in all major demos, delivering more than half of the year's top 50 cable telecasts. ESPN's first college football playoff actually delivered the three biggest audiences in cable history, as well as an 83% ratings increase over the prior year's bowl championship series.

The company also indicated that early sales trends during the current quarter were good:

So far this quarter (Q1 2016), ESPN's ad sales are pacing up significantly compared to last year, reflecting a very strong advertising marketplace for sports and the timing of key college football bowl games.

Regarding cable programming costs, Disney said that costs could increase in the high-teens during the first quarter, fall in the high-teens during the second quarter, and increase only in the low to mid-single digits in fiscal 2016.

Earlier, I mentioned that the six New Year's Eve and New Year's Day college football playoff bowl games will air in fiscal Q1 this year compared to fiscal Q2 last year. As a result, the costs associated with these games will shift into Q1, so we expect total cable programming and production costs to be up high-teens in Q1 and to be down high-teens in Q2.

In fiscal 2016, ESPN does not have any major new sports rights contracts kicking in, so we expect total cable programming and production costs to be up low to mid-single-digits for the year.

Therein lies the biggest risk for Disney stock post Q1 2016 earnings. You can expect Disney bears to pounce if the cable programming costs outpace Media Networks revenue growth and manage to negate the profit growth for the segment. It’s very likely that stellar performance byStar Wars: The Force Awakens will accelerate Disney’s top and bottom line growth during the upcoming earnings call. But Disney bears might end up calling the shots on the day if Media Networks reports considerably narrower profits or even a loss.

By the same token, Disney bulls might enjoy a field day when the company reports Q2 2016 earnings due to the projected decline in programming costs.

Investor Takeaway

It’s already a well-known fact by Disney investors that Star Wars has performed exceptionally well and is likely to give a significant boost to the company’s Q1 2016 performance. The fact that Disney shares have remained depressed despite this fact tells you that the bears won’t relent until Disney’s Media Networks reports impressive numbers during its upcoming earnings call. Since there is so much pessimism already baked into Disney stock price on account of ESPN weaknesses, I don’t expect the shares to sell off by more than 5%-7% in the days following the earnings calls before starting to slowly recover. Long-term investors should not be fazed if Disney reports lower-than-expected profits for its Media Networks segment but should instead hold on to the stock and wait for the trend to reverse in the coming quarters.