By
Ravee Mehta
:
Those who are familiar with my work know that I like it when
investment ideas remind me of prior decisions that have worked out
well.
Corning
(
GLW
) reminds me of other cyclical stocks that have done well once
earnings estimates first start to get revised upwards. A year ago,
the Street was expecting Corning to earn $2.00 per share in 2013.
Today, the consensus expectation for 2013 EPS is $1.43. In early
2011, Corning was trading above $22. It is now below $13, which
puts it at 9x 2013 EPS and below book value. The company recently
increased its dividend (yield of close to 3%).
Corning is involved in several businesses, but most of its
earnings currently come from LCD glass. The LCD glass industry went
into oversupply, because of two simultaneous events. First, the
weak economy caused demand to be weaker than expected for LCD TVs,
computer monitors and laptops. Second, the industry started a
transition to using thinner glass, which effectively increased
supply. The industry is currently half-way through this transition.
The oversupply caused pricing pressure and market share loss for
Corning and was the primary reason for the dramatic cut in earnings
expectations for the company.
Corning responded by taking close to a quarter of its own
capacity offline. Since Corning has about half of the industry's
supply, this move resulted in a moderation of pricing pressure. On
the company's Q2 earnings call, CFO Jim Flaws stated, "Our quarter
two price declines for LCD glass were indeed much more moderate
than the previous two quarters." During the question and answer
session of the call, Flaws also stated, "I'm delighted by the Q3
pricing that we basically have reached agreement with almost all of
our customers already." With pricing more of a known variable, the
company appears to be set to beat earnings expectations in the
short term for several reasons:
-
Demand has turned out to be better than
expected.
Since Corning's last earnings call, there have been many industry
data-points that imply strengthening business conditions.
AU Optronics
(
AUO
), one of Corning's largest customers, reported September quarter
revenue that was better than expected. When AUO initially gave Q3
guidance at the end of July, it expected large panel shipments to
be flat sequentially from Q2. Actual shipments wound up being up
close to 5% sequentially. A couple of weeks ago, Nippon Electric
Glass (NEG), the number 3 manufacturer of LCD glass, also revised
upward its expectations for the September quarter. Retail TV
Demand from China during its Golden Week Holiday appears to have
been better than expected. This is important since Corning's CFO
specifically highlighted Chinese demand as the biggest
risk-factor during the Q2 earnings call. He stated, "I feel our
biggest risk is our television forecast is China." Despite all
these positive industry data points, consensus estimates for
Corning's Q3 have barely changed.
-
Currency has gone in Corning's favor.
Something many people usually miss is that the company prices
much of its LCD glass in Japanese yen. The yen has strengthened
versus Q2. The stronger yen will not only help the company beat
short-term expectations, but it will also give even more
confidence to bulls who are looking for continued moderation in
pricing pressure.
-
The company has become more aggressive with returning
capital to shareholders.
It recently increased its dividend by 20%. Corning also bought
back close to 2% of its total shares outstanding in Q2. This was
at a faster pace than Q1. The Street does not appear to be
accurately modeling Corning's share buyback going forward. Most
expect the company's share count to increase going forward when
it should be decreasing.
People who are bearish on Corning will point out how the stock
has recently risen from slightly below $11 to about $13 per share
in a couple of months. They will affirm that recent data points are
already "priced in." The problem with this point of view is that it
fails to take into account the larger context. While the stock has
done well recently, it has still underperformed massively over the
last couple of years. A large portion of industry supply has been
taken off-line and the most painful part of the transition to thin
glass is in the rear-view mirror. At the current valuation, the
stock is not priced like a company that is expected to beat
earnings expectations. The price-to-earnings multiple at 9x can
only go up from here and it
should
go up given the improved certainty around industry pricing and the
return to growth. Q4 should be the first quarter in a long time
when revenue and EPS inflect back to positive year-over-year
growth. This is usually a positive for the multiples of cyclical
companies.
Longer term, there are several potential positive scenarios for
the company. I do not necessarily have a strong view about any of
these, but at the current valuation, I think of the stock as a
cheap call option (Actually, it's better than a call option,
because instead of paying premium, I get paid close to a 3%
dividend to wait). The positive scenarios:
-
Large new business opportunities and diversification
should help the stock's price-to-earnings multiple.
Corning is an R&D company that has regularly reinvented
itself over its long history. During the dot-com bubble, it was
primarily known as a supplier of fiber optics and it is currently
viewed as a manufacturer of LCD glass. The company's labs are
constantly churning out new technologies. It is only a matter of
time until one or more of these new products become another big
business for the company. Furthermore, because some of the
technologies Corning is working on leverage its existing
manufacturing facilities, there is the potential that its success
leads to better industry supply conditions and pricing for LCD
glass. The company's effort in glass for solar panels is one
example. Corning is working on lightweight glass that would
protect solar panels but also would make them much more efficient
at generating electricity. Since the Street is not modeling
anything from this new business, any success in this area would
be a source of earnings upside. Moreover, since solar glass would
be made with LCD glass factories, success in solar glass could
also lead to upside in pricing for LCD glass. Even without a
large new explosive business, Corning's earnings should become
more diversified over time as other businesses are expected to
grow faster than LCD. In an upgrade note published in
mid-September, Goldman Sachs noted that it expects Corning's LCD
business to account for 74% of earnings in 2013 down from 96% in
2009. The diversification should lead to less cyclicality and
increased predictability over time. This, in turn, should improve
the stock's multiple.
-
Replacement demand and a housing recovery could drive an
upturn in LCD TVs.
According to the company, the average LCD TV is replaced about
every 6.5 years. This replacement rate implies that a very small
amount of current TV demand is for replacement. However, that
will change in a couple of years. In 2008, there were about 118
million LCD TV units sold. Replacement demand for these units
could drive an upturn in overall TV demand in 2014. Furthermore,
while many expect housing to recover, current TV demand
expectations assume little to no correlation to housing.
Therefore, any positive correlation could lead to upside. I
hypothesize that the correlation is higher than people think. I
personally bought a new TV when I recently moved into a new
apartment and I know several other people where this was also the
case. Since industry supply has been taken off-line, any
significant upside surprise in demand could cause pricing to
actually go up for a short period of time. This has happened in
the past and there is no reason why it can't happen one day again
if demand improves.
-
Windows 8 could drive an improvement in PC
demand.
While most believe that the PC market is secularly challenged,
there is an argument that PC demand is also cyclically depressed
ahead of the launch of Windows 8. Any significant cyclical
improvement could lead to upside to industry demand
projections.
Of course, there is also the risk that Christmas demand for TVs
and PCs is very weak. Retail demand will be the main variable to
monitor. The Japanese yen is another variable to keep an eye on. As
of now, channel inventories appear to be in good shape and I feel
relatively confident with the stock's risk / reward. A stock's
price is a function of earnings and the multiple applied to its
earnings. Both the earnings and the multiple are more likely to be
revised upward than downward after Corning's Q3 results are
reported. I am apparently not alone in thinking this. Several
corporate insiders have bought stock at around this same price over
the last several months.
Disclosure:
I am long [[GLW]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
this article.
Disclaimer:
The author may make trades in securities mentioned without
notification. The information contained in this article is
impersonal and not tailored to the investment needs of any specific
person. You should consult with a professional where appropriate.
The author shall not be liable for any loss of profit or any other
commercial damages, including but not limited to special,
incidental, consequential, or other damages.
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