Shanghai—Disney's gateway to the Middle Kingdom

Published Mon, May 4 201510:55 AM EDTUpdated Tue, May 5 20155:46 AM EDT

Evelyn Cheng @in/evelyn-cheng-53b23624 @chengevelyn

As Mickey puts his largest castle in China, investors should watch Disney stock. The opening of Shanghai Disneyland gives significant upside potential to the company's profits and share price as Disney can expand all aspects of its brand as it enters the lucrative mainland China market. It may be a reason to stick with shares of the Robert Iger -led juggernaut that's quadrupled on the back of a "Frozen"-fueled ecosystem in America. The "theme park business is a disproportionate driver of the stock," said Barton Crockett, senior research analyst at FBR Capital Markets, which has an "outperform" rating on Disney and a price target of $120 a share. That's a 9 percent upside from the company's closing price of $110.52 a share on Friday. With "generation after generation" of visitors, Crockett said the durability in Disney's theme park attendance makes it the most profitable of any similar parks in the world. And if Shanghai Disneyland, slated to open in spring of 2016, performs just as well as Disney's Florida or Japan parks, Crockett said the company could increase profits by 10 percent. Read More This is how one trader made millions on Disney Construction on the Shanghai Disney Resort began in April 2011. The completed park will include Shanghai Disneyland, two hotels, and other entertainment and recreational venues. The entire complex will span 963 acres, triple the size of the Hong Kong resort. At capacity, Shanghai Disneyland will be the company's second-largest theme park destination in the world, CFO Jay Rasulo said at Nomura's investors conference in 2013. Jefferies analyst John Janedis saw enough potential from Shanghai to focus on it in his report that raised the price target to $120 from $105 a share. "Given underlying organic growth/asset mix, we expect the stock's valuation to remain decoupled from media and continue to drift upwards toward the consumer staples' valuation range," Janedis said in the report. China's middle class of an estimated more than half billion is expected to continue growing in size and purchasing power, while remaining highly brand conscious. The latest figures from McKinsey project Chinese urban, private consumption to reach 26.804 trillion yuan ($4.31 trillion) by 2022, more than double that of 2012. The opening of Shanghai Disneyland taps into that increased spending power and strong brand awareness. "Disney understands that this is great, great brand value to the Disney name in theme parks, merchandise and filmed content," said Lindsay Conner, partner at the law firm Manatt, Phelps & Phillips. He recently negotiated one of the first major investments by a Chinese company in a Hollywood film studio. "From a film, entertainment standpoint, China is the final frontier," he said. From a "theme park perspective, China is a huge market. Merchandise can go everywhere." Jefferies' Janedis forecasts 10 million visitors in the first year, and nearly 18 million annually five years after the theme park opens. With that attendance, he expects ticketing revenue to increase from $386 million in the first year to $884 million in the fifth year. The model projects profitability in Shanghai within three years. For Disney overall, Janedis expects an increase of more than 12 percent in revenue from this year to fiscal 2017. Immediate boosts to revenue could come from the Shanghai Disney Store, the brand's largest retail site in the world slated to open later this year. China is also on track to become the world's largest box office. Disney's "Avengers: Age of Ultron" opens there on May 12. The company said box office sales were $90 million in China for the first Avengers film in 2012. Read More Why Avengers sequel will break records: Expert "From a film perspective China is now (the) second-largest box office, (and) will surpass the U.S. in the next four years. It is the biggest underserved market on earth," Conner said. "While U.S. box office is stable, the Chinese box office is exploding." Disney reports earnings for its fiscal second quarter on Tuesday. Analysts polled by Reuters expect the company to post revenue growth of 5 percent to $12 billion, with a 1 percent decline in earnings per share to $1.10. For the full fiscal year ending in September, analysts forecast a 7 percent increase in revenue and a 14 percent rise in earnings per share. To be sure, analysts noted that Disney's venture into China brings challenges from success with locals to intellectual property protection. Homebrewed versions of Winnie the Pooh and other characters can be found on items in Chinese markets, and film piracy is common. Even the publishing arm's "Disney English" language learning centers in China have sprouted knockoffs. With 33 locations in the country, the language centers use Disney characters in the classrooms and curriculum. The Chinese Foreign Teachers Union, a whistleblower blog , noted in 2012 that many individuals printed their own business cards with the Disney logo in attempt to pass themselves off "Disney English" teachers. Read More The force is with Disney: Michael Eisner Ultimately, the opening of a major theme park will bolster Disney's presence in a significant market. "Shanghai should make China a much bigger part of the Disney story," FBR's Crockett said. "Strategically speaking, if you're the largest entertainment business in the world you want to be in the country with the fastest growth and largest box office."

Entertainers perform during the groundbreaking ceremony for Walt Disney's Shanghai Disney Resort on Friday, April 8, 2011.

Qilai Shen | Bloomberg | Getty Images

As Mickey puts his largest castle in China, investors should watch Disney stock.

The opening of Shanghai Disneyland gives significant upside potential to the company's profits and share price as Disney can expand all aspects of its brand as it enters the lucrative mainland China market.

It may be a reason to stick with shares of the Robert Iger-led juggernaut that's quadrupled on the back of a "Frozen"-fueled ecosystem in America.