Corning More Undervalued Than PPG Industries

Includes: GLW, PPG
by: Takeover Analyst

In an earlier article, I argued that Corning (NYSE:GLW) was undervalued enough to justify its risks. The piece received positive feedback, so I thought it would be worthwhile to put it under the context of competition. Although there is no true "peer" to Corning, PPG Industries comes arguably the closest. PPG produces decorative coatings, optical materials, commodity chemicals and glass. It has had 11 consecutive quarters of beating consensus estimates and yet revisions to EPS have gone down versus up 5 to 1. Coupled with its high beta, the firm's bar is set low by the market, which allows for generation of high risk-adjusted returns.

From a multiples perspective, Corning is nevertheless significantly more undervalued. It trades at a respective 6.3x and 7.5x past and forward earnings, while PPG trades at a respective 12.6x and 11.8x past and forward earnings. Interestingly, over the last 24 months, Corning has lost more than a quarter of its market value while PPG appreciated by 40.6%. Going forward, I see Corning better able to handle inflationary pressures with more innovative products. While a lower planned capex of $1.8B for 2012 gives me pause, Gorilla glass remains a major catalyst for the firm, under appreciated by the market. As the leading producer of ceramics and glass substrates for LCD, Corning has strong pricing power and has accordingly held up well despite contractions in the supply chain inventories of panel makers.

At the third quarter earnings call, PPG's chairman and CEO, Chuck Bunch, noted impressive results:

"Today we announced third quarter sales of $3.8 billion, up 11% versus the third quarter of 2010. Our third quarter earnings per share of $1.96 were a record for any quarter in the company's history and up 24% versus the prior year. This represents five consecutive quarters in which we have eclipsed our prior quarterly earnings record, including last quarter where our earnings were also up more than 20%.

This consistent improvement in performance, especially in light of today's economic backdrop, demonstrates our management's aggressive focus on operations and the continuing benefit of structural changes that we have made to the company the past few years, including a lower cost base and expansion in emerging regions."

While the major catalyst for Corning is in its products, the major catalyst for PPG is in financial performance. The firm is doing well cleaning off the balance sheet and I anticipate net debt declining by around $1B over the next three years. By 2013, ROIC may grow as much as 430 bps to 19.8%. At the same time, management is committed to returning free cash flow to shareholders. Greater share repurchases are anticipated, which will be accretive to EPS and drive value creation.

And as far as margins are concerned, PPG has done well with pricing increases, as oil-based raw materials are becoming less of a pricing pressure. The poor housing market will limit returns in performance coatings, but the CEO is taking the right long term focus. On a more pessimistic note, Thailand flooding will negatively impact the fourth quarter more than what many investors were expecting, as revealed by PPG declaring force majeure.

Consensus estimates for PPG's EPS are that it will grow by 33% to $6.89 in 2011 and then by 4.8% and 10% more in the following two years. Assuming a 12x multiple and a conservative 2012 EPS estimate of $7.15, the rough intrinsic value of the stock is $85.50. This implies a nominal margin of safety that does not, in my view, merit calling the firm a value play. On the other hand, I value Corning at an intrinsic value of $23.25, as a base case - a significant premium to the market value. Thus, in closing, I believe that while PPG has its financial and operational opportunities, Corning represents a more lucrative investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.