Buy Corning At A Discount

| About: Corning Inc. (GLW)

Corning (NYSE:GLW) is the leading global supplier of glass and ceramic substrates. Founded in 1851 as Corning Glass Works, Corning has reinvented itself numerous times over it's 160 year history to position itself as a global leader in five different market segments:

  1. Display Technologies: Glass substrates for LCD panels in various consumer electronic devices. Represents 40% of 2011 sales.

  2. Environmental Technologies: Ceramic substrates and filters for emission control systems. Represents 13% of 2011 sales.

  3. Telecommunications: Optical fiber, cable, and hardware and equipment for telephone and internet communication networks. Represents 26% of 2011 sales.

  4. Life Sciences: Optical biosensors for drug discovery. Represents 8% of 2011 sales.

  5. Specialty Materials: Advanced optics and specialty glass solutions including Gorilla Glass. Represents 14% of 2011 sales.

Although much of Corning's revenue comes from the Display Technologies segment, most of the recent growth has come from other segments. Gorilla Glass has seen significant growth, nearly tripling sales from 2010 to 2011. Gorilla Glass is used in many mobile devices like smartphones and tablets.


Let's take a look at Corning's financial picture:

2007 2008 2009 2010 2011
Revenue (Mil $) $5,860 $5,948 $5,395 $6,632 $7,890
Operating Cash Flow (Mil $) $2,077 $2,128 $2,077 $3,835 $3,189
Capital Expenditures (Mil $) $1,267 $1,921 $890 $1,007 $2,432
Free Cash Flow (Mil $) $810 $207 $1,187 $2,828 $757
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A few things stand out about the cash flows in the last five years. First, the operating cash flow for 2010 showed a large increase from the prior year. This was due partially to a one-time special dividend of $900 from affiliate Samsung Corning Precision. Second, capital expenditures were significantly above the average in 2011. This was the result of expanding capacity for Gorilla Glass and other investments made to meet demand for its various segments. Corning projects capital expenditures of about $1.8 billion in 2012.

Owner Earnings

Owner Earnings is a better measure for valuation purposes than free cash flow. Warren Buffett defines Owner Earnings as follows:

These represent (1) reported earnings plus (2) depreciation, depletion, amortization, and certain other non-cash charges... less (3) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume... Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (3) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes.

I'll calculate Owner earnings by taking the 5-year average capital expenditure and subtracting that from the operating cash flow. I'll also subtract stock-based compensation from the operating cash flow since it has a dilutive effect on the company but is routinely included in the cash flow figure. I'll also add interest payments adjusted for taxes since interest is tax deductible.

2007 2008 2009 2010 2011
Operating Cash Flow (Mil $) $2,077 $2,128 $2,077 $3,835 $3,189
Interest Payments (Mil $) $82 $59 $82 $109 $89
Stock-based Comp. (Mil $) $0 $118 $127 $92 $86
Average Capex (Mil $) $1,503 $1,503 $1,503 $1,503 $1,503
Owner Earnings (Mil $) $645 $558 $518 $2,335 $1,677
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Owner earnings smooth out capital expenditures and provide a clearer picture of the profitability of the company. Let's use the Owner Earnings figures to determine Corning's Cash Return on Invested Capital, or CROIC. This is the cash return generated by the company on invested capital, and is simply the Owner Earnings divided by the total invested capital. This is a better measure than ROIC because ROIC relies on earnings, which is a poor measure of profitability.

2007 2008 2009 2010 2011
Owner Earnings (Mil $) $645 $558 $518 $2,335 $1,677
Invested Capital (Mil $) $15,215 $19,256 $21,295 $25,833 $27,848
CROIC 4.3% 2.9% 2.4% 9.0% 6.0%
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Corning's CROIC for 2011 was 6%, which means that given, say, $1 million of investment (retained earnings for example) the company will generate $60,000 in cash on that investment. This is a fairly low rate of return, and since in the long-term, a company will grow roughly at its CROIC, Corning is not a particularly fast growing company. Let's look at the balance sheet.

Cash and Cash Equivalents (Mil $) $5,825
Investments (Mil $) $4,726
Debt (Mil $) $2,391
Pension Obligation (Mil $) $897
Minority Interest (Mil $) $51
Net Cash (Mil $) $7,212
Float (Mil) 1,583
Cash/Share $4.56
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Corning has a strong balance sheet, with $4.56 in cash and investments. Let's put a value on Corning to determine if the company is undervalued at current prices.


I use a discounted cash flow analysis to determine the fair value of a company. I use a discount rate of 15%. I will use an initial growth rate for the owner earnings of 6% and allow that growth rate to decay over 20 years to a perpetual growth rate of 3% as per the schedule below.

Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
% 6% 5.85% 5.7% 5.55% 5.4% 5.25% 5.1% 4.95% 4.8% 4.65%
Year 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
% 4.5% 4.35% 4.2% 4.05% 3.9% 3.75% 3.6% 3.45% 3.3% 3.15%
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Under these assumptions, the fair value of a share of Corning is $15.38. The stock is currently trading for $14.02, which is a discount to the fair value. Buy targets for various margins of safety are listed below.

Margin of Safety Buy Target
10% $13.84
15% $13.07
20% $12.30
25% $11.54
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With a 52-week range of $11.51-$22.05, Corning has seen prices below a 20% margin of safety fairly recently. Currently, it does not offer a large enough discount to fair value to justify opening or expanding a position, but it has traded at prices below $13 within the last month, so large dips may offer an opportunity to buy Corning at a significant discount.

Disclosure: I am long GLW.