Seeking Alpha
Profile| Send Message|
( followers)  

By Ishtiaq Ahmed

Corning (NYSE:GLW) had a flat year after enjoying two years of substantial growth. As a result, the stock of the company has been hovering around the $13 mark. I wanted to see why the market was so skeptical about the stock. Is it just the current disappointing results or the future prospects are really grim for Corning? I decided to conduct a fair value analysis based on the future earnings and growth prospects of the company.

Model Assumptions:

Like any other financial model, there are certain assumptions about the revenue growth, cost structure and capital structure of the company. In recent year, the company has enjoyed revenue growth of about 10%. However, in my ProForma earnings estimate, I have assumed a 2% revenue growth for 2012, and 5% in the years from 2013 to 2016. At the end of 2016, I have assumed a constant growth rate of 2.5%.

In the current year, Corning has faced declining revenue growth in its LCD segment. However, the revenue for the fourth quarter will be high for Corning due to increased sales in emerging markets as well as, developed world due to the holiday period. Although, the LCD segment faces decline in revenue, growth in Telecom segment and Medical Sciences segment will make up for the fall in the future. In addition, the growth prospects in emerging economies will make up for the loss in the developed world. Please refer to my previous article about a detailed analysis of where I believe the growth will come for Corning.

Cost of sales for Corning has been approaching 55% in the previous two years. As a result, I have kept the cost of sales at 55%, as the company has a unique and fairly stable manufacturing process. Selling and general expenses have been increasing at about 2% for the company. Corning spends 9% of its revenues in research and development, and it is a vital expense for Corning. I have kept R&D expense at 9%. Corning tax obligation has been increasing due to its operations in high corporate tax countries. The company conducts business all over the world, and different tax rates are charged to its earnings every year. The company expects the tax rate to increase in future. For 2011, Corning reported provision for taxes at around 12%. However, in my model I have raised the tax to 15% and kept it constant throughout the projections period.

ProForma Earnings:

 

 

 

Reported Earnings

Projected Earnings

 
 

2010

2011

2012

2013

2014

2015

2016

2017

Net Sales

$6,632

$7,890

$8,048

$8,450

$8,873

$9,316

$9,782

$10,027

Cost Of Sales

$3,583

$4,324

$4,426

$4,648

$4,880

$5,124

$5,380

$5,515

CGS as a percentage of Revenue

54.03%

54.80%

55.00%

55.00%

55.00%

55.00%

55.00%

55.00%

Gross Margin

$3,049

$3,566

$3,622

$3,803

$3,993

$4,192

$4,402

$4,512

Operating Expenses:

        

Selling general and administrative expenses

$1,015

$1,033

$1,054

$1,075

$1,096

$1,118

$1,141

$1,163

Research development and engineering expenses

$603

$671

$724

$761

$799

$838

$880

$902

R&D as a percentage of Revenue

9%

9%

9%

9%

9%

9%

9%

9%

Amortization of purchased intangibles

$8

$15

$12

$9

$18

$13

$7

$11

Asbestos Litigation Charge

-$49

$24

$11

$15

$15

$15

$15

$15

Operating Income

$1,472

$1,823

$1,821

$1,943

$2,065

$2,208

$2,359

$2,420

Equity in Earnings of the affiliated companies

$1,958

$1,471

$1,156

$1,179

$1,203

$1,227

$1,251

$1,276

Interest income

$11

$19

$20

$22

$23

$25

$28

$31

Interest Expense

$109

$89

$88

$89

$90

$90

$91

$92

Other Income, net

$184

$118

$72

$69

$75

$78

$82

$82

Income before Taxes

$3,516

$3,342

$2,981

$3,125

$3,276

$3,447

$3,629

$3,717

Provision for Taxes

$287

$408

$447

$469

$491

$517

$544

$558

Tax Rate

8.16%

12.21%

15.00%

15.00%

15.00%

15.00%

15.00%

15.00%

Net Income

$3,229

$2,934

$2,534

$2,656

$2,785

$2,930

$3,085

$3,160

EPS (basic)

$2.07

$1.88

$1.62

$1.70

$1.78

$1.88

$1.97

$2.02

EPS (diluted)

$2.04

$1.85

$1.60

$1.68

$1.76

$1.85

$1.95

$2.00

Even with these conservative revenue growth assumptions the company will be able to generate impressive earnings during the valuation period.

Valuation:

For the valuation purposes, I have assumed a discount rate of 9%. Corning has a strong history of revenue growth, healthy cash reserves and a strong business model. Taking into account the strong position of the company, I believe a discount rate of 9% is justified.

Valuation

2012

2013

2014

2015

2016

2017

Earnings

$1.60

$1.68

$1.76

$1.85

$1.95

$2.00

Discount rate

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

Present Value Factors

0.98

0.92

0.84

0.77

0.71

0.65

Discounted Earnings

$1.56

$1.54

$1.48

$1.43

$1.38

$1.30

Terminal year Value @2.5% constant growth

     

$22.74

Discounted Terminal Value

     

$14.78

True Value

$23.48

     

There are two conventional methods to calculate the terminal year value; multiple of terminal year earnings and a constant growth model. I have used the latter, and assumed a 2.5% constant growth rate after the high growth period of four years. Furthermore, the terminal year earnings of $2 are discounted using the single stage growth model, where the earnings are first adjusted for constant growth and then discounted by the discount rate of 9%. The single stage growth model also adjusts discount rate for growth by deducting the terminal growth rate from the discount rate. Once the terminal year value is calculated; it is then discounted to reach at the present value. On the other hand, earnings before the terminal year are simply discounted to reach at the present value. Finally, the discounted earnings are added to the discounted terminal value to reach at the true value/fair value of the stock. According to my valuation model, Corning has the potential to go to around $23, given its growth prospects. The stock is currently trading at a significant discount to its fair value.

Competition:

 

Corning

TEL

MMM

DOW Chemical

P/E

8.90

9.60

13.30

9.8

P/B

0.90

1.90

4.00

1.80

P/S

2.70

1.00

2.30

0.6

EPS Growth

-18.90%

-0.66%

6.80%

-11.53%

Operating Margin

18.80%

11.44%

21.30%

5.36%

Net Margin

28.60%

7.92%

14.60%

3.84%

ROE TTM

10.50%

14.25%

25.70%

9.34%

Debt to Equity

0.20

0.49

0.30

0.89

Source: Morningstar.com

The main competitors for Corning are TE Connectivity (NYSE:TEL), 3M (NYSE:MMM) and Dow Chemical (NYSE:DOW). It is evident from the table that the stock is trading at a discount as compared to its competitors based on multiples. EPS growth indicates that the sector as a whole is facing declining EPS as three of the four companies recorded negative EPS growth. In addition, the company demonstrates strong profitability and the margins for Corning are impressive compared to its competitors. Only 3M shows better margins than Corning, but the stock is trading at a significant premium compared to Corning.

Summary:

My fair value analysis indicates that the stock has substantial upside potential. I believe the market has become too pessimistic about the future of LCD. At the moment, the stock is trading at a P/E of 9 and P/B ratio of 0.9 along with a dividend yield of 2.66%. Investors investing at these prices will essentially get future growth for free. At present, only zero growth in the future can justify the stock price. However, I believe there are opportunities for growth in the market and the use of Corning's products will increase. I remain confident that the company will be able to achieve substantial growth and GLW will prove to be a shrewd long term investment.

Source: How Much Is Corning Worth?