40% Upside on Corning Right Now


Corning is a 71-cent dollar assuming zero growth in its free cash flows.It has compelling fundamental factors such as a 7 year average profit margin of 22% and 3 year average ROE of 21.67%. It has little debt with total debt to capital at 10%, market cap of 19.5B and a quick ratio of 3.32.


Guest post by

Joakim Aske

This is a continuation of Joakim Aske’s very detailed analysis of Corning. You can read the first one that answers Fisher’s 15 Scuttlebutt questions.

Investment Snapshot

  • Investment Thesis: BUY
  • Current Price: $13.30 (at the time of writing)
  • Target Price: $18.65
  • Upside: 40%

Corning has 40% Upside Investment Case Overview

Corning is a 71-cent dollar assuming zero growth in its free cash flows.

It has compelling fundamental factors such as a 7 year average profit margin of 22% and 3 year average ROE of 21.67%. It has little debt with total debt to capital at 10%, market cap of 19.5B and a quick ratio of 3.32.

Conservative assumptions for the valuation methods yield values significantly above market price. It is currently trading at 0.93 P/B and 7.48 P/E.

GLW has initiated a 1.5billion share repurchase and has spent half of that so far. Its current dividend yield is 2.30%.

These factors combined creates a valuable investment opportunity where there is little downside and significant upside even with conservative valuation methods.

Donald Yacktman has recently purchased shares in GLW and Oakmark holds GLW shares, both are high performing value oriented funds.

Gordon Gund, director, purchased shares for 1.9 million March 6th 2012. Last time he bought shares was in Nov. 2008.

Margin of Safety

Base Scenario

  • Assuming 2011 EBIT declines with 30%. Guidance is 30% reduction in subsidiary EBIT, not on a consolidated basis.
  • Tax rate is 35% but management assumes 20%
  • With FCF of 2284.49M, assumed growth rate of 0% and using required return of 10% the upside is 40.23%
  • It takes a required return of 15.5% to eliminate the EPV(earnings power value) upside

Reducing EBIT by 65% is required to get to an equal value to today’s share price with the EPV method, using a 10% required return

Factors Depressing the Price

Psychology

There has been a barrage of bad news for GLW regarding the excess capacity in the LCD substrate market.

This combined with a significant inventory trimming in the supply chain to levels not seen since the market crash in 08-09 have caused reduced profitability and sales for the SCP subsidiary and GLW’s display segment.

Complex Financial Structure

Corning has two large subsidiaries, which is not included in its consolidated financial statements.

These two are important to GLW, however, only their revenues are reported through other income in GLW’s consolidated statements. Their impact on a truly consolidated cash flow, balance sheet and income statement is less available for the lazy analyst/investor.

Short term focus

The issues that have emerged within the polysilicon industry and the excess capacity within the LCD substrate market are serious, however, they are short-term problems that are not causing losses for GLW.

This combined with the high degree of uncertainty in the world is causing investors not to see through the fog that clouds the intrinsic value of GLW.

There is also an expected decline in subsidiary EBIT of 30%.

Gorilla glass appears unprofitable due to an impairment write down of 130 million.

Company Profile

Corning is a global, technology-based corporation that operates in five reportable segments and has two material subsidiaries.

Display Technologies

Produces glass for screens(LCD/OLED/AMOLED). Tablets, computers, TVs, Cars, Architectural opportunities are markets for Corning’s Glass.

Telecommunications

Producer of fiber optics and wireless internet equipment

Environmental Technologies

Manufactures emission filters for diesel engines and other end users. The world’s fleet of trucks and cars will be requiring emission filters until a different fuel source is developed, not to mention regulations worldwide is tightening to fight CO2 emissions.

Specialty Materials

Gorilla Glass is a durable and scratch resistant type of glass currently used by more than 30 major brands, designed into hundreds of product models, and featured on more than 600 million devices.

Life Sciences

Corning have been a leading developer, manufacturer and global supplier of scientific laboratory products for more than 90 years.

Dow-Corning (50% ownership)

Dow Corning provides performance-enhancing solutions to serve the diverse needs of more than 25,000 customers worldwide. A global leader in silicones, silicon-based technology and innovation, Dow Corning offers more than 7,000 products and services via the company’s Dow Corning® and XIAMETER® brands.

Dow-Corning is involved in the research and sales of silicone material for solar cell manufacturing, assembly and installation.

Hemlock Semiconductor Group (GLW`s ownership 31.5%) is the third largest polysilicone producer worldwide. A supply gut has currently started and is estimated to last a few years as the industry has entered a shakeout period. Hemlock is one of the lowest cost producers and is expected to weather the period.

Samsung Corning Precision(SCP) (50% ownership)

SCP is a leading LCD high quality glass-substrate producer. Joint venture with Samsung, one of the world’s leading LCD TV producers.

Corning newly formed an equity venture with Samsung that plans to produce OLED glass solutions using Corning’s Lotus™ Glass substrate technology.

Management

  • Wendel P. Weeks CEO/Chairman
  • Current management has a clean record.
  • Management is developed internally; current CEO has been with GLW for 29 years.
  • Proven long-term commitment – See appendix 3 for analysis of 10 years shareholder letters.
  • Focused on the factors that increases value for the shareholders. I.E. increased FCF, higher profitability, stability in financials, profitable growth
  • They have launched a share repurchase program, in the last half of 2011, for 1.5 billion USD that they intend to utilize while their stock price is below its intrinsic value.
  • Increased dividends and share repurchases remains an option, they have more than 8 billion in cash and securities, as the fog of uncertainty is lifted its likely that either one of these will be selected by the board.
  • Management has a good share of their compensation in form of long-term options.
  • Gordon Gund, director, purchased shares for 1.9 million March 6th 2012. Last time he bought shares was in Nov. 2008.

Competition

Below is an overview of the 3 key players in the glass industry, which is GLW’s main business segment (+80% of income derives from it).

It is clear that GLW is in a completely different position than Nippon and Asahi based on the margins. GLW has been able to charge a premium on its products due to the quality. It also holds a majority market share in the glass market it supplies.

Competitive Advantage

Formidable Research Company

  • Invented Edison light Bulb, Television Tube, Glass ceramic, Low loss optical fiber, Ceramic filters for diesel/gasoline engines, LCD glass and in 2007 the Gorilla Glass.
  • Corning increased its patent count by 19% and holds twice as many patents granted in the last year than its closest competitor. The company also improved its Science Strength™ by 37%, and maintains an Industry Impact™ almost double the industry average.

Economies of Scale

  • “You’ve never outsourced manufacturing. How come? We are the world’s lowest-cost producer of everything we make, so manufacturing is a significant competitive advantage for us. Much of our competition is based in Asia, and 70 percent of our revenue comes from outside the U.S. We have plants in most areas where we have customers.” (GLW CEO, March 2010)
  • GLW is constantly moving its glass production towards producing thinner glass while keeping the quality of it the same. Combine this with the cost of producing glass is measured by the pound and you have GLW`s ability to keep its margins high while average selling price for LCD TV’s and other products are declining steadily. The trend is also for larger and larger screens, which functions as a tailwind for GLW.
  • Holds significant market share in diesel filter market, potentially +50%.

Brand – Superior Quality

In its optical fiber, LCD glass substrate, scratch resistant glass, ceramic filter markets, it is the leading manufacturer with first mover advantage, furthest along the learning curve, have the products with the highest quality in the market and is the original inventor of the product itself.

This enables GLW to charge premiums in many of its markets compared to its competitors. These are defended with superior quality compared to its competitor and its position ahead of them in research and know how.

Customers Requirement Continue to Increase

The products GLW produces may seem from an initial glance as commodity products; however, every year customers for these products demand improvements and increased standards. It is very hard for an entrant to be able to set up the necessary business operations and stay up to date on the newest standard that GLW constantly is improving. An entrant cannot just beat GLW’s current products and start producing them, as by the time they become fully operational to deliver to customers the product they were beating GLW on will be outdated.

Part 2 is next

Risks, valuation, risk/reward discussion, catalysts and more coming in the next part…

Stay tuned.

  • Choubix

    FCF are much lower for FY2011, 2285 is the FY2010 number.
    I sent a screenshot to Jae with the correct numbers. DCF valuation will be much lower than current market price at 0pct growth and 10pct discount rate.

  • Joakim

    The FCF is calculated for an EPV valuation assuming 0% growth, therefore I have added back parts of R&D and marketing expenses into the FCF estimation. 130M non recurring charge is also added back. Wait for the next part and you will see my full reasoning.

  • Buck

    Fascinating work! I really appreciate your insightful analysis.

    Now for the difficult questions:
    How did you discover this undervalued stock?
    Do you already own this stock?

    Thanks again for a most interesting article.

  • @Joakim, this is awesome stuff. You’ve confirmed my suspicions. Bought GLW a while back, and happy to hold on for a while. 2.1% ain’t amazing, but a 2.1% with a 40% upside is great. Nice being paid to wait.

  • BL

    Been a long-term holder of glw. Was thinking of adding at current prices. Great write-up. Just read part 2 as well!

  • Joakim

    @Buck, I have been focusing on testing my ability to generate investment ideas for a imaginary 10 billion dollar hedge fund, which means an investment idea should be able to hold 2-4 billion dollars without going above 30% ownership. So its because of this that I investigated GLW after seeing their “a day made of glass” video.

    I wish I had the funds to invest in it. Though, I am sure there are even better ideas out there in the 5M+ marketcap global universe of stocks. Which is where im searching for my next writeup.

    @Graeme, I prefer to have a dividend while waiting, it makes me more comfortable to wait for the increase in price.

  • Buck

    @Joakim,
    Thanks for the response. I, too, saw the day made of glass video and was inspired. Great analysis. I’m tracking it now as a result of your article.

    Buck

  • Seth

    Corning (GLW)has an interesting history. This company is located near my home town and as such I have been familiar with the companies ups and downs since childhood. Let me start off by saying that I am long Corning and is is substantial part of my current portfolio.

    The following is not an exhaustive list, but just a few things off the top of my head.

    Positives:

    -Corning has a history of remaining profitable and reinventing itself as the market changes.

    -Corning puts a lot of resources towards R&D which allows them to remain ahead of the curve.

    -They have a large cash reserve that makes me more comfortable

    -Recently increased dividends

    -Recently initiated a share repurchase program.

    Negatives:

    -Corning has had a track record of over committing to specific markets. This happened with the fiber market in the late ’90s the stock went to $300 and then split 3 ways. within a few years it was trading near $1. Many millionaires were made and destroyed in Upstate NY during this time.

    -Large pool of stock options. The company favored the use of stock options for employee bonuses. This along with the after effects of Cornings earlier swan dive has held the stock range bound around $20 ever since it’s recovery. Each time the stock rises in to the low $20’s options are executed driving the price back down (at least this is the theory).

    In the end whether the stock remains range bound at these levels or not there is value at the current price. I think the undervaluation is derived largely out of memory of Corning as a fallen angel of the fiber era. I am long GLW and will be adding to my position.

  • Joseph D Williamson

    I have a few concerns about the margin of safety of a Corning investment at the present moment. First, using Ycharts as a source, its current FCF on one hand is higher than the average FCF TTM of the last 10 years. On one hand, this is a positive sign as it shows the FCF TTM is growing. On the other hand, it provides insight into what a conservative estimate of FCF TTM should be. I would argue that using the current FFM TTM of 759M constitutes a conservative starting point for valuation. However, when using this number to arrive at a FCF/EV ratio, one receives a disappointing metric of roughly 4%. Furthermore, the current CROIC of 2.18% in no way constitutes a margin of safety sufficient enough for those who are most concerned with the risk of capital loss and here’s why: there is no way Corning can get a lower cost on their debt or equity.
    Also, I would like to call into question the validity of the price/book or price/tangible book metric for valuation in this case (it happens to be that both metrics are almost identical in Corning’s case). A technology company like Corning is subject to rapid product deflation because of the way technological innovation improves product while lowering prices. For this reason, I would argue that time is the enemy of the price/book ratios in this case.
    I will finish by pointing out the main difference between my quantitative analysis and the one by Jae is that I am using only FCF TTM metrics for valuation as I believe they are most relevant and from what I’ve read in Jae’s other articles, I think he may understand where I am coming from on this. According to Forbes data, Corning’s FCF TTM/EBIT TTM is roughly 19.3%. This is a source of concern because even though the EPV excludes growth, it still may be unjustifiably larger than a conservative investor would be comfortable with since the importance of FCF trumps that of EBIT.
    My analysis is by no means conclusive so I’m throwing it out here for others to try and pick apart.

    Disclosure: I have one April Covered Call and one April Cash Secured Put position on Corning but I am considering getting out at the first hiccup in the market that bring the share price back up to $14 per share.

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