As I noted in responding to the bull case for Corning (GLW) last month, Corning investors tend to have a long-term focus. With the stock stuck in a 15-month trading range, and clear challenges facing its Display Technologies segment, even many GLW shareholders would likely admit that, earnings aside, there are few short-term catalysts for the share price.
As such, many GLW shareholders would likely view Wednesday's drop following the release of third quarter earnings as simply yet another short-term bump on Corning's long-term grind back to previous earnings and share price levels. But there's a problem with that thesis: the quarterly results were actually halfway decent. As Forbes noted, earnings beat analyst estimates on the bottom line, while matching on the top line.
Rather, it was the commentary from management, notably a pessimistic outlook for 2013, that seems to have spooked the market. In Display Technologies, still the company's primary profit driver, glass price declines were "moderate, as expected," according to the earnings release. But the company also expected "slightly" higher price declines in Q4, while VP Tony Tripeny told Forbes in an interview that the company was lowering its estimate for retail glass consumption for the full year. The culprit was lower PC sales, a trend that has similarly knocked down share prices at other tech titans such as Intel (INTC) and Dell (DELL). CFO James Flaws blamed some of the company's struggles on the economy, saying in the release that "The weakening economy is affecting sales in many of our businesses...We believe these economic headwinds will persist next year."
That's true as far as it goes, but there are more than just macroeconomic headwinds affecting Corning's bottom line. Display Technologies remains the company's profit driver, having created 78 percent of the company's net income in 2012, and the business is simply under attack. Television manufacturers are reeling, PC monitor sales are down, meaning a business model that is already based on declining prices now is seeing revenue declines as well (Display sales are down 11% year-to-date). The combined effect means Display profits are down by one-third in 2012. This is not just a macroeconomic issue; this is a result of considerable weakness and price competition in television manufacturing, and the faster-than-expected decline of the PC. These are specific, long-term, structural challenges facing Corning's glass products that go beyond the economy and do not appear to have an easy fix. Flaws noted in the Q4 conference call in January that the company had reached "a new floor in terms of profitability." In the Display segment, Q3 results provide little reason for investors to expect a return to old earnings levels any time soon.
The problem for Corning is, that no matter how much its supporters claim otherwise, its other four segments are simply not strong enough to overcome weakness in Display. The one bright spot for Corning this quarter was the performance of the Specialty Materials segment, led by the company's Gorilla Glass product. Sales jumped 21% year-over-year, with earnings rising by better than 50 percent.
But the year-over-year addition of profit to Corning was just $21 million; for the year, it looks like Specialty Materials' net income should rise about $80-$90 million. Meanwhile, Display saw its earnings drop by $159 million in the third quarter alone. In the first nine months, Display net income is down $625 million from the year-prior period; total net income for the four other segments was just $338 million, barely half of the lost profits from the glass business. And beyond Gorilla Glass, Corning's other divisions struggled, with quarterly revenues dropping 4-7% and net income falling in Telecommunications, Environmental Technologies, and Life Sciences.
Corning's pending acquisition of Becton Dickinson's (BDX) life sciences business may help a bit in that segment; but right now the smaller divisions cannot, on their own, bring Corning earnings back to 2010-11 levels. It seems clear that the glass business will be challenged as well through at least 2013, meaning it seems plausible that Corning's earnings will drop again next year. A 10% drop in net income from Display and a 30% gain in net income from the rest of the company would still result in total net income declining next year. With the company's repurchase program wrapping up in Q4 (according to the release), even 30% earnings growth outside of Display would cause 2013 EPS to drop below the trailing figure of $1.30 and a likely $1.25 per share or so figure for 2012. That's how important the glass business is to Corning.
At GLW's current price of $12.08 (down about 9.9% as of this writing), that puts its forward P/E in the range of 9-10. That's not unrealistic for a company with sharply declining earnings that is facing structural changes to its business. And as this quarter shows, those challenges cannot be overstated. In previous articles, many commenters have mentioned their hopes for Corning's earnings to "normalize" to previous levels. That is not going to happen any time soon. For the company to return to 2011's $1.77 per share, earnings must grow about 40 percent from the 2012 baseline. Without a rebound in Display, profits in the other four segments must triple. But so far in 2012 they have actually declined, by over 11 percent. Corning is indeed at "a new floor" in terms of earnings, and it will be a long, hard slog to boost net income even from this new, lower level. Today's earnings report shows just how difficult the process will be going forward, and it shows why the stock is priced accordingly.