Corning (GLW) shares closed up 7.1% as of this writing to $14.30, after the company announced first quarter earnings that beat Wall Street expectations. The news was welcome for GLW bulls and shareholders, who have seen the stock lag the broad market in 2012, stuck in a range some 30-40% off its early 2011 highs.
But as a GLW skeptic, I don't see much in this quarter's earnings report that dramatically enhances the bull case for the stock. Taking Wall Street expectations out of the equation, Corning saw flat revenues, higher costs, and sharply lower equity affiliate earnings lead to a 38% drop in net profit year-over-year. That is not normally the type of quarter that leads to a 7% jump.
Indeed, the first quarter emphasized, rather than mitigated, the challenges facing the company. The Display Technologies segment -- the key driver for the company's earnings -- saw revenues fall 9.6% sequentially and 10.8% from the prior-year-quarter. Profits in the segment fell 34% year-over-year and even 14% sequentially. The sequential drop is particularly troubling, given that it was fourth-quarter weakness in Display that knocked the stock down 12.5% in the week those earnings were released. The company's four other segments -- Telecommunications, Life Sciences, Environmental Technologies, and Specialty Materials -- posted net income totaling $94 million. That total -- equal to just six cents per share -- was about 22.3% of the net income from Display, showing that Display remains the key driver of the company's earnings machine.
And yet, Display is under continued pressure. As CFO James Flaws noted in the conference call, margins in the Display segment fell in Q1 from the prior quarter. Volume is expected to rise slightly at Samsung Corning Products (one of the company's equity affiliates) and stay flat in Corning's wholly-owned division. Yet with "much more moderate" price declines ahead, revenues and earnings in the segment look to be flat, at best, going forward.
In the other four segments -- cited by bulls as a undervalued part of the company, as Gregory Lemelson wrote this morning -- growth was hardly impressive. Revenue grew 7.3% year-over-year, but total net income grew by just 1 percent. Coming on the heels of 29% non-Display revenue growth -- and 180% net income growth -- in full-year 2011, those numbers should be disappointing to GLW investors.
In short, nothing in Wednesday's earnings report has changed the issues facing Corning, issues I discussed when I called the stock a "value trap" back in January. The Display Technologies segment will remain under pressure; the entire television supply chain is under attack as producers post billion-dollar losses. As the company itself noted in the Q4 conference call, the accelerated pricing declines in Q4 of 2011 and Q1 of 2012 were not a matter of simple inventory allocation or world economic problems; they were required by the company's customers, who "continue to operate on unhealthy financial levels." Demand for PCs and tablets does not appear to be picking up the slack; the company expects the total retail demand for glass to rise about 10% by square footage in 2012 (a forecast reiterated today). Given increased "yield" (as customers use glass more efficiently) and lower pricing per square foot, growth in the segment seems unlikely at best.
The company chose to highlight its sequential growth in the other four segments in the conference call, but as noted, year-over-year growth was in the single digits. Corning boasted of 21% sequential growth in the Specialty Materials segment -- led by demand for the company's vaunted "Gorilla Glass" product -- but failed to point out that Gorilla Glass sales fell 25% sequentially last quarter. The company no longer breaks out Gorilla Glass sales (perhaps because it had originally guided for $1 billion in sales for the product in 2011, only to see the final number come in at $710 million) but it seems unlikely that the product has even returned to Q3 sales levels. That product, often touted as a replacement for lower legacy glass and equity earnings, needs to be a blockbuster for Corning to succeed; so far, it has been good, but not good enough. Without Gorilla Glass posting substantial year-over-year growth (sales nearly tripled in 2011), the non-Display divisions will not make up for the struggles in the Display Technologies segment. (As an aside, the company guided for 10-15% sequential growth in Specialty Materials for Q2, putting year-over-growth at 17% on the high side. After 13% growth in Q1, it looks unlikely that Gorilla Glass will reach its $1 billion sales target in 2012, let alone in 2011 as originally forecast.)
In the meantime, equity earnings continue to fall. After falling 26.4% in 2011, they fell another 45% in the first quarter year-over-year, and 32% sequentially. The company is forecasting a slight rise in equity earnings sequentially, which would result in another 40-50% drop year-over-year in equity earnings for the second quarter. After earning nearly $1 per share from equity affiliates in 2011, those earnings look set to fall to the 50-60 cent per share range. From 2011's $1.77 per share in earnings, equity weakness alone might lower 2012 EPS to $1.30-$1.40. Add in the weakness in the Display segment and the 2012 consensus for $1.34 per share in earnings starts to look a bit optimistic.
Corning bulls like to point out the company's strong cash balance, but that too has been overstated. Net cash at year's end should be somewhere close to 50 cents per share or so. Yes, the company has over $4 per share in net cash; but it also has substantial debt (over $3 billion), and pension and other long-term liabilities. Netting out those liabilities -- and the BD acquisition, made after the first quarter close, and the $650 million remaining in the share repurchase authorization -- leaves about $200 million currently remaining. The company should generate free cash in the range of $400-$600 million for the next three quarters, putting year-end cash at about $600-$800 million, or 40-50 cents per share.
In short, if you look at the future of GLW, its status as a seemingly perfect, low-risk buy comes into serious question. Right now, it is touted as a stock that trades at $14.30 despite $4 per share in cash and trailing earnings of $1.60 per share. But at year's end, assuming no movement in the stock price, it will have a P/E near 11 and net cash well below $1 per share. It will still be facing serious headwinds toward any top-line growth; it will have seen its margins decline over the past year; and its major customers -- from TV manufacturers to every electronics manufacturer not named Apple (AAPL) -- will still be facing inflationary pressures on the cost side and economic pressures on the revenue side. It will still get in the range of 70-75% of its profits from the glass business, in which it will (hopefully) still be facing "moderate price declines" and little, if any, growth.
Those are not the characteristics of a value stock. Corning may be a great company, and GLW a great stock, but not because they are "undervalued." They are well-covered, and well-understood. If the company can execute, stabilize pricing in the glass business, and grow its non-Display segments, then the stock will succeed. But on a valuation basis, GLW looks pretty well-valued, if you accept not only the "fundamentals" but the fundamental challenges buffeting the company right now. Wednesday's earnings, even if they were somewhat better-than-expected, don't change that fact.