I have been more skeptical than most of Corning's (NYSE:GLW) seemingly exalted status as a value stock. While the fundamental numbers still look outstanding -- over $2 per share in net cash, trailing P/E now below 8, and the stock trading at a discount to its book value -- I've argued that the company's earnings power is deteriorating quickly. Headwinds in the Display Technologies segment -- which still creates the majority of Corning's corporate earnings -- and in its equity affiliates are leading the company to what even its management admits is "a new floor in terms of profitability." Growth in the company's vaunted Gorilla Glass and its other, smaller segments such as Life Sciences simply will not overcome the substantial drop in earnings from the glass business and joint ventures such as Dow Corning.
Since Corning's first quarter earnings beat in late April, which caused a 7% jump I labeled as premature, the stock has struggled along with the broad market. But, for the company, evidence of near-term challenges continue to mount. In the Q1 conference call, Corning expressed hope that pricing in the glass market would continue to stabilize, and noted that Q2 price declines "would be much moderate." But the fiscal 2012 results from TV manufacturers this month don't give much confidence that Corning can instill pricing discipline any time soon. Panasonic (PC) lost some $10 billion in its fiscal year, with weakness in its television unit a key cause. LCD television sales fell 28 percent, and plasma TV sales fell 41 percent. Sony (NYSE:SNE) lost over $5 billion, with its Consumer Products division -- including televisions -- seeing a revenue drop over 18%. VP of Investor Relations Yoshihari Hashitani noted on the Q4 conference call that LCD sales would continue to fall, as the company focused on profitability over volume. And Sharp (OTCPK:SHCAF) also posted a record loss near $5 billion, again on weakness in its television unit. While Korean manufacturers such as LG Electronics (OTC:LGEAF) are having some success in the industry, and the Japanese makers offered somewhat optimistic guidance for a rebound, the pressures facing Corning's customers are clear. As Corning CFO Jim Flaws noted in the Q4 conference call, "our customers...continue to operate on unhealthy financial levels."
There is evidence, as iSuppli noted earlier this month, that the price war among the Asian manufacturers is abating. Flat-screen television prices have increased for the last four months; but this news is not necessarily good for Corning. The higher prices are coming from features such as Internet connectivity, larger size, and better resolution, as the manufacturers likely follow Sony's above-noted emphasis on profitability over volume. Those higher prices should limit demand, while the manufacturers' renewed focus on cost-cutting and margins limits Corning's negotiating power. The result is lower sales, lower prices, and lower profits in the Display segment, one of the company's key earnings drivers.
The other key earnings driver has been the company's equity affiliates, including glass maker Samsung Corning Precision Materials -- affected by the same issues as the Display segment -- and joint venture Dow Corning. Dow Corning reported its first quarter earnings on May 1st, with revenue down only a modest 4% year-over-year. Given the difficulties in the solar industry -- a key customer for the company's silicon and polysilicon products -- the sales decline was expected. But margins plunged -- "prices were depressed globally," as the company put it -- and net income fell 61%.
Pressures should continue for Dow Corning as well, as anti-dumping tariffs enacted last week against Chinese solar panel makers will hurt the company. As Bloomberg Government analysts Ken Monahan and Caitlin Webber noted, ""Higher prices of solar panels may decrease U.S. demand, which may exacerbate the oversupply of polysilicon." That oversupply has already led to the sharp earnings decline at Dow Corning, and its joint venture Hemlock Semiconductor, and the government's decision this week may drive the unit's margins even lower.
In short, despite the numbers, the primary sources of earnings power for Corning remain under significant duress. And the events of the last month cast doubt on some bulls' contentions that the glass business and equity affiliates are simply facing short-term headwinds. The television manufacturing business is undergoing a sea change amid the need for extensive restructuring and cost control -- as Reuters noted, the three major Japanese manufacturers lost some $21 billion combined in fiscal 2012. Growth in tablets and smartphones -- and continued adoption of Corning's Gorilla Glass -- can support Corning sales, but Corning's policy of price declines, improvements in yield, and the still-desperate financial situation of some key customers will continue to drive down margins. CFO Flaws said himself in the Q&A of the Q4 conference call that "we don't see a set of factors that would drive [gross margin] back up." The earnings decrease in the glass business is not a short-term result of economic weakness; it is a structural change in Corning's earnings power, based on a customer base that literally cannot afford to buy Corning glass at the prices it once did.
For Dow Corning, the upheaval in the solar industry will continue, as subsidies in Germany expire and the Solyndra "scandal" poisons support for solar subsidies in the US. Dow Corning's customers, like those of its parent, are not just facing short-term headwinds; many are literally fighting for survival. The resulting consolidation may be good for the industry in the long term; but it bodes poorly for margins at the silicone maker, and the recent addition of US tariffs should keep oversupply issues in place for the near future. The effect of these challenges is severe for Corning; its share of earnings from Dow Corning fell $54 million year-over-year in the first quarter. Its four segments outside Display -- Life Sciences, Specialty Materials, Telecommunications, and Environmental Technologies -- combined earned just $94 million in the same quarter. All told, the fall in equity earnings totaled $180 million year-over-year in Q1, dwarfing the earnings of the smaller, growing segments that many bulls tout as the company's counterbalance to weakness in glass and silicone.
There is a reason that GLW has stayed range-bound and seemingly undervalued for so long; it is facing a series of daunting challenges to its earnings power. In April, I argued that its most recent earnings report only served to underscore those challenges. Over the past few weeks, events throughout the industries which Corning serves have proven just how much pressure the company is facing, and just how long those pressures will last.