It's been two years now for shares of Corning (GLW), which have badly lagged the market since hitting a recent high of $22-23 per share in early 2011. GLW now trades at barely half those levels, closing Friday at $12.52.
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5-year chart of GLW (blue) versus S&P 500 (red); chart courtesy Yahoo! Finance
For those two years, Corning bulls have argued passionately for the stock, pointing to its low P/E multiple, its strong balance sheet, growth in business segments, and new products such as Gorilla Glass. Simply put, they've been wrong. The P/E multiple turned out to be appropriately compressed, as the market anticipated sharply declining earnings. Full-year earnings per share have been nearly halved, falling from $2.25 in 2010 to $1.15 in 2010, despite a reduction in share count. (To be fair, on a non-GAAP basis, the fall has not been as severe, but EPS has still fallen 38 percent.) The balance sheet, while still strong, has become less impressive, as net cash has fallen from $4 billion at the end of 2010 to $2.6 billion at the end of 2012. Growth outside of the dominant glass business has been weak, and while Gorilla Glass did $1 billion in sales in 2012, that came after the company originally forecast that it would hit that level in 2011.
And yet the coverage of the stock remains uniformly, stunningly bullish. It's as if the problems facing the company - clear, easily defined, tangible issues - simply don't exist. Corning has a very simple problem that is exceedingly difficult to combat: its legacy business sees prices decline every quarter, while its struggling customers are reducing orders and attempting to improve yield (the amount of Corning glass that actually makes it into the product, rather than being discarded during the manufacturing process). CFO James Flaws told investors on the third quarter conference call that the company had entered into arrangements with its customers to stabilize market share, but this does little to arrest price declines. Indeed, following Corning's fourth quarter earnings release in January, Flaws noted on that call that the agreements had actually increased price declines in Q4, though that rate was expected to moderate in the first quarter of 2013.
Corning's glass business is selling marginally more product at moderately lower prices, and making substantially less money. Net income in the Display Technologies segment fell from $3 billion in 2010 to $1.6 billion in 2012, with revenues falling 3.3 percent over that period. And there is no evidence of a rebound coming any time soon. Japanese television manufacturers are near collapse, while sluggish PC sales are limiting demand for computer monitors. On the Q4 call, Flaws projected the retail market would be up "mid-to-high single digits" in 2013. A small growth in demand and a small decline in pricing means that Corning's revenue base is likely to remain relatively unchanged. But higher input prices and a quickly depreciating yen would appear to show that Display earnings will again decline this year.
And that's all that matters. Display drives the overwhelming majority of Corning earnings, producing 82% of the company's net income in 2012. To offset a 10 percent decline in display earnings, the company's other four segments would need to grow net income by nearly 50 percent.
It's these segments - Telecom, Environmental Technologies, Life Sciences, and Specialty Materials (which includes Gorilla Glass) - which are touted as the savior for Corning. Yet, year-over-year, net income fell at three of those four segments, with only Specialty Materials showing bottom line growth. Total net income for the three declining segments in 2012 was $300 million, or just 20 cents per share.
Going forward, there's not much reason for renewed optimism in the non-glass businesses. On February 8th, the company issued a press release entitled "Corning Outlines Key Growth Opportunities." Corning's own documents show the limited ability of the company to outgrow declines in glass. Segment-by-segment, there's simply little for investors to get excited about:
- In Display, the company mentioned hopes for Willow Glass, along with potential new applications in OLED televisions. OLED televisions cost over $10,000 and Willow Glass is, by the company's own admission, at least three years away. By the time either product has the potential to even moderately boost Display revenue, pricing of legacy products will have decreased even further.
- Gorilla Glass "has the potential to more than double in sales over the next several years." If Specialty Materials sales triple and net margin doubles, net income in the segment would rise by roughly $660 million over that span. Net income in Display fell by $747 million in 2012 alone. Again, even outstanding performance from Gorilla Glass is not enough to overcome declines in Display. And Gorilla Glass, now beginning to mature, is facing the same price declines seen in Display, along with increased yield from its customers.
- There is "potential" double-digit growth in 2013 in the Telecom segment. But it's worth pointing out that in the fourth quarter 2011 conference call, CFO Flaws called Telecom "one of our fastest-growing businesses," and predicted "very strong growth" and "further gross margin expansion" in 2012. Revenues in the segment went on to increase by less than 3 percent and net income fell over 20 percent, as margins fell. Telecommunications created 8% of net income in 2012.
- Profitability at Environmental Technologies can grow "by more than 10% over the next several years." (I'm assuming that means 10% annually, though the phrasing makes it unclear.) A doubling of net income in the segment would, at that rate, take five to seven years and boost Corning earnings by roughly eight cents per share.
- Life Sciences is approaching $1 billion in sales, but no profitability or margin figures were broached. This may be due to the fact that the segment saw a net margin below five percent in 2012, and made the lowest contribution of any segment to the company-wide bottom line.
The company may call this a list of the company's "growth opportunities," but what Corning's own words instead highlight is just how difficult any sort of top- or bottom-line growth will be to achieve going forward. Analysts agree; earnings are again expected to decline in 2013, to $1.18 excluding special items before rising to $1.28 in 2014 - below even 2012's depressed levels.
Those earnings level, and the structural, long-term challenges facing Corning make its current valuation completely reasonable, at 10x trailing non-GAAP earnings per share and 13 times trailing free cash flow. There is, in fact, no evidence that the stock deserves a higher multiple, based on the projections made by Corning's own management.
It's also worth pointing out that management has been over-optimistic over the past few years. Not only did they over-estimate growth in Gorilla Glass and Telecom, in 2011 they confidently and repeatedly proclaimed a target of $10 billion in total sales by 2014. They will come nowhere close; with consensus revenue estimates for $8.77 billion for 2014, Corning's top-line growth looks set to be about half of what its management projected. That's why the stock has declined, and with little evidence that such growth will return, there's little reason to believe Corning stock will rebound accordingly.