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Corning Incorporated: Old Glass Substrates Manufacturer Undervalued?

October 09, 2011 | About:
Corning Incorporated (GLW) was founded originally in 1851, incorporated in New York in 1936, and changed its name from Corning Glass Works to Corning Incorporated in 1989. The business is technology development of glass in five main segments: Display Technologies, Telecommunications, Environment Technologies, Specialty Materials and Life Sciences. Altogether, GLW has around 60 plants in 14 countries.

Display Technologies, where GLW manufactures glass substraces for LCD to use mainly in notebook computers, flat panel desktop monitors and LCD TV, was around 45% of total sales in 2010. The next big segment is Telecommunications, which produces optical fiber and cable, hardware and equipment for the worldwide telecommunication industry. This segment accounted for 26% of total sales in 2010. The other two segments, Environmental Technologies and Specialty Materials, were 12% and 9% of the top line respectively in 2010.

The big item of raw material, as discussed in the annual report of 2010, was energy. In production, it requires a large amount of energy, uninterrupted power sources, some precious metals and various batch materials. The company says that energy shortages have not been the problem recently, but its cost was still quite volatile. However, GLW has made engineering changes to take advantage of low-cost energy sources in most significant processes. In addition, the availability of resources appeared to be enough.

In terms of customers, Corning has experienced quite a large concentration in customers in all of its segments. In Display Tech, for the two years of 2010 and 2009, three customers accounted for 72% and 62% respectively of the total segment sales. In Telecommunications, one customer accounted for 15% in 2010 and 12% in 2009 of net sales of the segment. For Environment Tech, three biggest customers took around 86%. In Specialty Materials in 2010, three customers accounted for 43%, and in life sciences, two customers represented 37% in 2010 of the total segment net sales.

Operating Performance

Historically in the past 10 years, its operation has been improving over time since the restructuring in 2001. Dated back in 2001, due to the business downturn, GLW undertook the restructuring program that closed seven major manufacturing facilities and consolidated some smaller facilities. In addition, it eliminated 12,000 positions under the restructuring plan. So for four years from 2001 – 2005, GLW took an operating loss due to huge restructuring charges, and some from fluctuation in raw material price fluctuations. The business turned profitable in 2005 and has stayed positive since then.

USD million 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Sales 6,272 3,164 3,090 3,854 4,579 5,174 5,860 5,948 5,395 6,632
Op. income -6,000 -2,720 -655 -1,453 613 846 1,081 1,520 391 1,801
Net income -5,498 -1,302 -223 -2,165 585 1,855 2,150 5,257 2,008 3,558


The bottom line has been improving since 2005 generally, with a surprising shot up in 2008, but it was non-operating. The net income jumped more than 100% in 2008 because it had the benefit of income tax items of around $2.4 billion, recognized in the income statement of the company, including the nearly $2 billion item of loss and tax credits carried forward.

Profitability

% Margin 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Gross 30.2 19 27.5 36.7 43.3 44.1 46.9 46 38.8 46
Operating -95.7 -86 -21.2 -37.7 13.4 16.4 18.4 25.6 7.2 27.2
Net -87.68 -45.2 -7.22 -56.18 12.78 35.85 36.69 88.38 37.22 53.65


In terms of profitability, the gross margin has been improving over time, but experienced wide fluctuation. It is the same with the operating and net margin. Excluding the extraordinary items, the operating margin and net margin are quite strong. Due to cyclical pressures, it is expected to have a contraction in margin in 2012, but the operating margin has been around 19% on average of the last five years. It has high probability to expect this double digit margin over the next five years.

We can see that the net margin and the net income are higher than the operating margin and operating income. Because the earnings it has from the affiliated companies it invested in classified as non-operating income, those investments are under equity method with a 20-50% stake. At the end of 2010, it records the nearly $3 billion of 50% in Samsung Corning Precision Materials, and nearly $1.2 billion of 50% in Dow Corning corporation.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Net Margin % -87.68 -45.2 -7.22 -56.18 12.78 35.85 36.69 88.38 37.22 53.65
Asset Turnover 0.41 0.26 0.28 0.38 0.44 0.43 0.41 0.35 0.27 0.28
Financial Leverage 2.36 2.55 2 2.59 1.99 1.8 1.6 1.43 1.37 1.33
Return on Equity % -68.54 -28.7 -4.5 -47.42 12.5 28.86 25.68 45.83 13.86 20.38


Since the company turned profitable, it has returned double digits on the amount of equity employed in the business, with the main contribution coming from the high net margin. Over time, GLW employed less and less leverage, from 2.6 in 2004 to only around 1.33 in 2010.

Cash flow

Over the last 10 years, GLW seems to be expanding its business gradually. With constant investment back into the operation as any capital intensive businesses do, it has somewhat dampened the free cash flow. However, with large increasing operating cash flow it has generated over time, the free cash flow is on a rising trend as well.

USD million 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
OCF 1,436 -264 133 1,009 1,939 1,803 2,077 2,128 2,077 3,835
CAPEX -1,800 -357 -366 -857 -1,553 -1,182 -1,267 -1,921 -890 -1,007
FCF -364 -621 -233 152 386 621 810 207 1,187 2,828


GLW experienced quite fast increases in OCF, only $133 million in 2003 and now in 2010, the OCF stays at $3.8 billion, nearly 30 times in only seven years.

Financial Strength

The business is quite conservatively financed. At the end of June 2011, GLW had a debt/asset ratio at 23.6%, whereas long-term debt and short-term debt combined is only around more than 8% of the total assets. In addition, GLW is quite liquid, with total cash and cash equivalents staying at nearly 23%, and the investment into equities in other corporations taking 18% of the total assets.

The market capitalization of GLW is at $21 billion at the moment, but if we adjust the level of cash it has and the little debt it owes, the enterprise value of the company would be just around $17 billion.

Relative Valuation

Currently, GLW is trading at low valuation relative to their historical five-year and the industry in general. The average five-year valuation for the company is 12x earnings multiple, and 9.9x cash flow multiples, whereas the industry average is 9.3x earnings and 7.9x cash flows.

For GLW, The P/B is 1.0, P/E is only 6.4 and P/CF is around only 5.8. But for enterprise value, the real P/E is only 5.2 and P/CF is only around 4.7. So for relative valuation, it clearly indicates GLW is relatively undervalued.

Free cash flow valuation

We would like to start with a conservative assumption, with the annual growth for the next five years of 3%. Then the free cash flow would grow to infinity at the rate of 1%, and the discount rate, as usual, at 10%.

Annual growth 3%
Infinity growth 1%
Discount rate 10%


With those assumptions, the value of GLW is laid out like this:

USD million 2011 2012 2013 2014 2015 Terminal Value
FV 2,913 3,000 3,090 3,183 3,278 47,303
PV 2,648 2,480 2,322 2,174 2,036 26,701
Estimated value 38,360


The estimated enterprise value for GLW is around $38 billion with conservative assumption above. So currently, it is trading only around 44% off its estimated intrinsic value.

Management

The management does not hold a significant stake in the company, over the long history dated back more than a century ago. The good point investors would like to see is the loyalty that the executives have for the company for nearly three decades. James Flaw, vice chairman of the board and CFO has been with the company since 1973, and Wendell Weeks, the chairman, president and the CEO has been with the company since 1983.

Conclusion

With the long foundation of glass production over more than a century, GLW and its 50%-owned subsidiary, Samsung Corning Precision, control more than half of the glass panel market and enjoy some of the highest margins in the industry. Along with the spread of LCD and smart-phones with touch-screen, there would be high probability that the company would grow quickly over the next several years. The company has generated consistent and rising operating cash flow and free cash flow over time, whereas it has deployed a quite conservative level of capitalization. GLW at this current market price is undervalued, more than 50% in free cash flow value estimation and the same level of discount with relative valuation.

This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 3.2/5 (19 votes)

Comments

sciomako
Sciomako - 2 years ago
You haven't read their 10K's in details, have you?

You used incorrect figures in your valuation because you didn't cater for equity accounting vs consolidation.
ken_hoang
Ken_hoang - 2 years ago
Hi Sciomako,

Thanks for the comments. For valuation, I used free cash flow to do the valuation, not the net income.

Pls detail here further in terms of equity acct and consolidation to arrive at the free cash flow figures. And what figures are correct according to you?

U mean the equity accounting is the transaction as follows in my analysis?

"Because the earnings it got from the affiliated companies it invested in classified as non-operating income. Those investments are under equity method with the stake of 20-50%. At the end of 2010, it records the nearly $3 billion of 50% in Samsung Corning Precision Materials, and nearly $1.2 billion of 50% in Dow Corning corporation."
Sivaram
Sivaram - 2 years ago


I took a quick look at Corning a few years ago and it does certainly seem cheaper now. If I'm not mistaken, it is a cyclical and may fall further if the economy weakens but it remains to be seen.

Who are the major competitors to Corning? Since you point out that a few customers account for most of the sales in each segment, how likely are they to switch to competitors? If Corning has superior product or better price, they are less likely to switch.
dealraker
Dealraker - 2 years ago
Anh,

Being a very, very, very young man.....

....you may want to do an investigation of how Corning- the stock price of Corning- has done since the mid......let's say 1960's. That long enough ago for you? Your data is interesting but like most very, very, very young aspiring financial types you also may want to read some Buffett quotes, particularly the ones that suggest that being a history major is a better basis for financial analysis than being a number cruncher.

If I am not mistaken Corning has "returned," including dividends, about 3 or 4 times investors money since the mid 1960's while nearly always having wonderful "brands" and being co-party to some incredible creations such as fiber optic cable.

Munger, I think, made some comments about Corning vs. Berkshire at some point and his reference to Berkshire's thousands of percents gain vs Corning suggested it was capital allocation that made the difference. GLW had a habit of expanding at the peak of the cycle and paying too dearly for assets soon to be worth less.

Corning is the anti-Henry Singleton run organization and reading the glossy annual report that repeatedly says, "We are at the forefront of invention and the future is just damn wonderful...."

(For management.)

Sivaram
Sivaram - 2 years ago


Dealraker,

Your point about weak capital allocation and long-term returns is worth keeping in mind; however, don't you think cyclicals like this can be bought at troughs?
fkattan
Fkattan premium member - 2 years ago
Thanks for the article.

Have you made an estimate of the real value of its assets, net of debt?

Regards,

matt83
Matt83 - 2 years ago
Dealraker...

...If one were to look past the condescending tone of your post, it might have actually been a worthwhile read...

...Key being might, might, might, might have been...

Are you mistaken or are you not mistaken in your expert opinion on total return? Facts please. A history buff such as yourself should know how to do simple mathematics like calculating a annualized rate of return. You may want to pick up one of those glossy sixth grade mathematics text books.

Everyone else. Sorry I wasted your time with this pointless post.

Anh,

Being a very, very, very young man.....

....you may want to do an investigation of how Corning- the stock price of Corning- has done since the mid......let's say 1960's. That long enough ago for you? Your data is interesting but like most very, very, very young aspiring financial types you also may want to read some Buffett quotes, particularly the ones that suggest that being a history major is a better basis for financial analysis than being a number cruncher.

If I am not mistaken Corning has "returned," including dividends, about 3 or 4 times investors money since the mid 1960's while nearly always having wonderful "brands" and being co-party to some incredible creations such as fiber optic cable.

Munger, I think, made some comments about Corning vs. Berkshire at some point and his reference to Berkshire's thousands of percents gain vs Corning suggested it was capital allocation that made the difference. GLW had a habit of expanding at the peak of the cycle and paying too dearly for assets soon to be worth less.

Corning is the anti-Henry Singleton run organization and reading the glossy annual report that repeatedly says, "We are at the forefront of invention and the future is just damn wonderful...."

(For management.)

nsh
Nsh - 2 years ago


The future is obvious here look at ur TV IPAD PHONE etc.... The key for the future of GLW is a breakdown of the competition and what advantage they have over them especially in regards to Gorrilla Glass. Anyone know?
Sivaram
Sivaram - 2 years ago


NSH: "The future is obvious here look at ur TV IPAD PHONE etc.... The key for the future of GLW is a breakdown of the competition and what advantage they have over them especially in regards to Gorrilla Glass. Anyone know?"

The problem, at least for the time being, is that most of the earnings for Corning comes from television and other display material, as opposed to the Gorilla glass (which they classify under speciality materials). This is why the stock price is off so much this year -- the market is pricing in a cyclical downturn in television and other display device sales.

I agree with you that the future potential looks good for the Gorilla glass but it is still a small business. Also, as you wonder, I'm not sure how strong their patent on that is; or how competitor products stack up against that.

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