Corning Undervalued at Current Levels

 |  Includes: AUO, GLW, LPL
by: Ronnie Moas

We have been watching Corning (NYSE:GLW) from the sidelines for some time and are ready to step in here. The shares have underperformed the S&P 500 by 1000 bps since Aug. 4, and underperformed the Nasdaq by 1500 bps. In our opinion, GLW is undervalued by more than 20%. Our price target is 11X-12X earnings potential of $2.00-$2.20 looking out to 2012. What is just as important as the upside here is that given the underperformance these last four months, GLW may outperform in a sideways or declining market (if we get a correction off the recent rally).

If the economy cooperates, our multiple and earnings forecast will prove conservative. If GLW goes back in favor, we could take out the three-year high of $27 from 2008 and the five-year high of $29 from 2006. If we were going to set a 2012-2013 price target (as opposed to 2011-2012 in the headline), it would be $27-$29.

In our S&P-500 report from Dec. 1, GLW ranked No. 54 out of 500 stocks according to our 155-variable computer model and passed our fundamental and subjective overlays (that we had been applying in recent weeks).


2005: $0.85; 2006: $1.12; 2007: $1.40; 2008: $1.52; 2009: $1.35;

2010: $2.08; 2011: $1.93; 2012: $2.10

GLW shares are currently trading at < 10X earnings and earnings purity is 95%. P/CF is < 8X while EV/EBITDA is < 7X. Five-year revenue and EPS growth figures are 4% and 13%, respectively. The revenue figure is a bit lower than what we would like to see, but should improve going forward with management plans to increase revenues by 40% between now and 2015. The one area of concern on the GLW profile is on P/S, but that can be disregarded as it is offset by a very high net profit margin.

This recommendation is no slam dunk, especially in the near-term. New devices are bringing the television closer to the user and making it smaller. This is not a tremendous threat to the big screen televisions, but it is a headwind. In the near-term, growth in this industry may be hard to come by as the LCD industry relies on the large televisions heavily that account for > 50% of its demand. This is already baked into the GLW valuation by a stock market that obsesses over weekly, monthly and quarterly figures instead of looking out 18-36 months as we are doing. You want to buy GLW here before the good news comes out, because if you wait until then, it will be too late.

AU Optronics (NYSE:AUO), one of the firms competing with GLW, recently reported an October sales decline of 16% versus September. It was its second worst October in the 2006-2010 timeframe. This industry is dominated by GLW and a bunch of Asian companies including AUO, LG Display (NYSE:LPL), Sumitomo and Furukawa. Corning reported a weak Q3 on Nov. 1 and provided a soft 4Q LCD outlook. That being said, the shares are trading a bit higher than where they were before that announcement. We do not expect much from this market in the near-term, but would begin to build a position here. Margins are being pressured and inventory levels are high. Inventories spiked by 17% sequentially, the biggest quarter-over-quarter uptick in 10 years.

The market is probably more focused on the LCD business than it should be. GLW is a solid company with diversified revenue streams, although there is a bit of concentration there that has something to do with the low multiple the market is attaching to its earnings. GLW has opportunities in environmental technology and solar and should at the same time be able to hold its market share position in the markets it dominates.

Corning delivered Q3 earnings of $0.51 per share versus the consensus of $0.52; revenues rose 8.3% year/year to $1.6 billion versus the $1.61 billion consensus. Sales in the Display Technologies segment were $645 million, declining 23% sequentially and 5% year/year. Display Technologies' performance benefited from a favorable Japanese yen-to-U.S. dollar exchange rate in the quarter. Glass price declines in the third quarter were comparable to the second quarter.

GLW witnessed a modest increase in utilization rates in October. Management believes this is in response to expectations for good worldwide retail demand during the upcoming holiday season. GLW glass demand forecast is based on the assumption panel maker utilization rates will remain modestly higher for the remainder of the fourth quarter in comparison to a much weaker September. That being said, panel maker utilization rates this quarter may not rebound to the level they were prior to the inventory correction. As a result, worldwide glass market demand could be flat to down slightly quarter to quarter.

Glass pricing is expected to decline in the mid-single digit range in the fourth quarter. This decline would be more than previous quarters and reflects pricing pressure caused by the current imbalance of glass supply and demand.

Corning possesses considerable advantages in the market for LCD TV glass substrate. The company has developed great economies of scale, having continuously improved upon its manufacturing technology. Corning has developed one of the most efficient methods to produce the glass substrate and patented it, allowing for production of larger and thinner panels at lower cost. With this advanced technology, GLW has obtained a majority of glass market share, as it has been able to keep pace with the rising demands of its customers (Samsung, Phillips and Sony).

Some are concerned that demand for LCD TVs in the U.S. has stalled, with market penetration of more than 80%. But others point out that demand for the product has continued to be strong in other parts of the world. Retail sales in the U.S. were down during Q3, while sales growth in Asia and South America were in the high double-digits. The company believes that shipments for the year will be approximately 28% higher than in 2009.

In the most recent quarter, sales at its Display Technologies segment were down 23% from Q2 and volume was down 25%. As a result of lower volumes, margins also fell from the previous quarter. The company believes that its sales and EPS in Q4 will be lower than in Q3 as a result of falling glass prices in the mid-single digits as well as excess supply of glass in the market.

As of the end of 2009, however, the GLW Display Technologies segment made up only 45% of total sales. In addition to sales from this product, Corning earns a substantial proportion of its revenue from its Telecom division, and also has stakes in Environmental Technologies, Life Sciences and Specialty Materials (31%, 11%, 7%, and 6% of sales respectively).

As part of its Telecom division, GLW produces optical fibers and cables. In Q3, sales in this segment were up 5% from the previous quarter while net income nearly doubled, attributable to a decreasing cost structure. While long-haul networks drove growth in this segment in the past, demand for fiber-to-home technology has driven recent growth as internet activities demanding greater bandwidth like VoIP, data streaming and online video have placed a strain on networks run on copper wires. Increasing traffic on smart devices, growth in cloud computing and enterprise investment in IT is expected to propel growth going forward. Corning’s Specialty Materials division has also been a source of sales growth lately due to strong demand for its Gorilla Glass.

This glass is being used in more than 140 different products, mainly as a cover material for laptops and handheld devices, and the company expects to add another 90 products during the next six months bringing the total to more than 230. The popularity of this glass appears to be in its early stages. GLW has reported receiving requests from automakers, appliance designers and architectural industries, which could provide additional revenue opportunities in the future. The company projects sales of the glass to exit the year at a run rate of about $450 million attributable to use in handhelds and IT products. Corning’s CFO Jim Flaws believes that Gorilla sales could reach $1 billion in 2011.

Disclosure: No positions