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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 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
- 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
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.
Corning is a global, technology-based corporation that operates in five reportable segments and has two material subsidiaries.
Produces glass for screens(LCD/OLED/AMOLED). Tablets, computers, TVs, Cars, Architectural opportunities are markets for Corning’s Glass.
Producer of fiber optics and wireless internet equipment
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.
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.
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.
- 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.
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.
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…
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