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Daniel Seens
Daniel Seens
Articles (79)  | Author's Website |

Corning: An Investment for Income and Growth

Valuation reveals an appealing opportunity

When you hear the name Corning (NYSE:GLW), what else would you possibly think of other than glass?

Corning makes drinking glasses, glass tableware and all sorts of other items made of glass. That said, the company is much more than a boring commodity-based company. In fact, it is a premiere technology materials company that contributes significantly to the smartphone, tablet, laptop and flat-screen television industries. If you own any of these devices, regardless of brand, chances are pretty good that the glass on the screen was produced by Corning. Chances are also pretty good that the images and data transmitted on these devices have traveled through glass-based fiber-optic materials produced by Corning.

The company

In total, Corning operates in five segments, all built on a glass-based foundation. Display Technologies account for about 40% of company revenues and are generated primarily from sales of liquid crystal display screens. The Optical Communications segment accounts for about 27% of company revenues and are generated primarily from fiber-optic cable sales and an assortment of connectivity and other products related to fiber for telecommunications companies, LAN and data center applications. Corning has a Specialty Materials segment, accounting for about 12% of sales, that produces a wide assortment of high-tech, glass-based materials, including those specialty glass screens for smartphones, tablets and laptops. This segment is showing increased success in the automotive and architectural markets.

Also out of this division comes new bendable display technologies known as Willow Glass as well as a series of glass and ceramic products used in the semiconductor industry, precision instruments and even astronomy and ophthalmology. The Environmental Technologies segment accounts for 11% of revenues and is aimed toward making ceramic filters for emission control systems, mostly for gasoline and diesel engines. Corning also has a Life Sciences segment, accounting for 9% of sales, that makes laboratory glass and plastic products.

The company competes within a fairly intense industry, with most top competitors coming from Japan. Recently in 2014 Corning acquired the remaining 50% stake in a Corning-Samsung (XKRX:005930) joint venture helping it to secure a low-cost, highly efficient, production capacity in Korea. This added about $1 billion to Corning’s top line.

The company is highly innovative and has many promising products in its pipeline, including its new “Willow Glass.” This is a type of pliable, ultrathin glass that is particularly sensitive to touch and is helping to reduce the size and weight characteristics of mobile devices. Now this is evolving into bendable, curved and curvable glass displays. Also noteworthy are the company’s new “Dynamic Windows”  architectural glass panels that automatically darken, reducing energy consumption. This is particularly exciting for office tower, household and vehicle windows. The company stands to benefit significantly into the long term.

Purchase considerations

We like companies that are largely insensitive to broad stock market movements. Our Colgate-Palmolive (NYSE:CL), Coca-Cola (NYSE:KO) and Morningstar (NASDAQ:MORN) picks seem to do well regardless of which direction the market moves.

Further, as a top supplier to most competitors, including Samsung and Apple (NASDAQ:AAPL), really it doesn’t matter to Corning who dominates the industry or how market shares shift; Corning still comes out on top. It’s also the same as it relates to the tablet and laptop markets. Corning dominates the supply channel, so Corning wins!

The explosion in demand for smart devices and the need for the technologies that Corning produces will continue to support growth and margins moving forward. Screen technologies in the wearable mobile computing device industry, such as smart watches, will provide an additional kick for the company somewhere down the road. The core business also remains well intact. The company’s revenues have grown far beyond levels reached prior to the dot-com bubble. It also owns a nice chunk of the world’s fiber-optic market and has come to be known as a technology leader.

Corning continues to differentiate its product line. While there are strong competitors internationally, and while Corning doesn’t have a monopoly on the market, it is still probably the innovation leader in the market. For those who like growth stocks in a strong and profitable technology segment, Corning is a good candidate. The company is profitable, generates plenty of cash flow and pays nice dividends.

While its product portfolio is better than most of the competition, the company does remain sensitive to business and inventory cycles. Glass, without the right application, is a pure commodity-type business, and the recent strengthening of Japanese competition due to the strengthening U.S. dollar is presenting some challenges. If price erosion due to increased competition resulting from the strengthening dollar outpaces margin gains from innovation, growing product demand and cost savings initiatives, Corning might not be the best place to invest.

Estimating sales growth

When assessing the competitive strength and investment merit of any firm, the first thing we like to do is to look at what’s going on with sales that’s really the first level of inquiry that any investor should undertake. Ideally, we are looking to invest in companies whose sales are strong, consistent and generally growing faster than nominal GDP growth (that is, real GDP growth and inflation combined). Based on Corning’s historical sales data, you can see that things have been reasonable. The 10-year sales growth has been 6.1% a year. This compares to nominal GDP growth of 3.3% per year over the same period. Back in 2000, Corning's sales got hammered due to changing consumer preferences and a massive oversupply of global fiberoptic capacity. Since 2003, sales have grown at a significant pace due primarily to the massive surge in demand for screen displays.

Overall the company is on solid ground and retains substanital pricing power. We feel comfortable saying you can invest in this company if you're looking for steady sales. Corning’s sales growth has been 3.5% per year over the last five years and 6.3% per year over the last three years. Corning's three-year revenue growth is actually ranked higher than 86% of the 1,942 companies in the Global Electronic Components Industry. Sales will continue to grow at a steady pace of an estimated 3% per year over the next few years, and investors can continue to expect good and predictable things from this company in the future.

Figure 1: Revenues ($ millions) and revenue growth (%)

The second thing we like to do when assessing sales is to look at consensus market estimates. As reported in Yahoo Finance, the market is projecting 3.4% annual growth for this year and 1.5% for next year. These estimates are drawn from the projections of 15 analysts. The sales estimate is $10 billion for 2017, which compares to the year ago estimate of $9.7 billion. Note that the market is expecting 1.5% growth for next year, which would infer total sales of 10.2 billion.

A third thing we like to do when assessing sales is compute the firm's sustainable growth rate. The sustainable growth rate reflects the rate of growth in sales that a firm can support given its existing earnings power, capital resources, and dividend payout policy. In any given year, a firm's sustainable growth rate is calculated by multiplying its return on equity (ROE) by its retention rate. Rather than rely on data from only one year, however, we calculate sustainable growth by using the firm's three-year average ROE and three-year average retention rate. Corning's ROE averaged 12.3% over the last three years while its retention rate averaged 70.7%, giving the firm a sustainable growth rate of 8.7% per year.

Let's recap briefly what the sales data is showing us. From what we can tell, it is not unreasonable to estimate that sales over the next five years could grow at a rate of somewhere between 2% and 9%.

Table 1: Choices for possible growth rates

Growth Rate (%)

Rationale

6

The 3-Year Growth Rate

4

The 5-Year Growth Rate

6

The 10-Year Growth Rate

2

The 2-year average consensus growth estimate

0

The firm's guided growth rate

9

The Sustainable Growth Rate

We're going to select a rate of 2.9%. With $9.4 billion in sales generated last year, this means sales will continue to grow in the future and will reach about $10.8 billion in five years. This estimate reflects our understanding of the firm's historical results, market demand, population growth, pricing trends, product innovations and changing consumer preferences.

Estimating earnings per share

Now that we have generated our sales estimates, we’re going to estimate growth in earnings per share. This method applied below takes the sales growth projection in this case, 2.9% per year and subtracts the expenses and taxes. What we're left with are the earnings. Then we divide by the projected number of diluted shares outstanding to determine the earnings per share (see table below).

A projected growth rate of 2.9% will result in almost $10.8 billion in sales five years out. Now we need to take a look at the firm's pretax profit margin (what’s left over after expenses but before taxes are subtracted). In Figure 2 below, we can see that Corning produces some pretty unstable margins 31.6% in 2013, 36.7% in 2014, 16.3% in 2015, and 39.3% in 2016. The average for the last five years has been 29.7%, and the average for the last 10 years has been 35.4%. Corning's margins will normalize at its medium-term mean of 30.0%. At this rate, projected pretax profits on $10.8 billion in sales would be just over $3.2 billion. This means expenses would amount to $7.6 billion.

Figure 2: Pretax profit margins (%)

The next step in our estimation process is to establish the tax rate that will be paid on the company's profits. For Corning over the last 10 years, the company's tax rate has been as low as -82.4% and as high as 30.7%. Tax rates for most U.S. companies will fluctuate between 35% and 40%. We're going to select a rate of 25.0%, representing the average rate of the last 10 years, excluding the influence of nonrepresentative years. This would result in a tax expense of $812 million from pretax profits of $3.2 billion in five years. This would leave us with $2.4 billion in projected earnings five years from now.

Our next main consideration is a matter of determining the number of diluted shares that will be outstanding in five years. Corning has decreased the number of shares outstanding over the last decade. There were 1.566 billion shares outstanding in 2007, then the number of shares went to 1.583 billion in 2011 and then fell to 1.144 billion in 2016. This data suggests that the company has been redeeming about 42 million shares per year. We're going to rely on the company's historical share repurchase activities to guide our estimation process. As such, we project share repurchases of 42 million per year over the next five years.

With shares estimated at 934 million in five years, EPS is expected to fall at a compound rate of -4.2% over the period. This is lower than our projected five-year revenue growth rate and reflects definite margin compression due to intensified competition. Note that it doesn't always work out this way. Based on this EPS growth forecast, EPS of $2.61 seems likely five years out. Results of our forecasting procedure are summarized in the table below.

Table 2: Path from projected sales to projected earnings

Forecasting a target P/E multiple

Now we need to take a look at the price history of the company's stock. From Figure 3, we can see that the spread between the high and low stock prices has declined modestly over the last 10 years. We have a current price of $27.41 with a high in the past 10 years of $24.94 and a low of about $10.88. We want to keep this variability in mind when establishing our upper and lower valuation range. Specifically, given the firm's historical stock price behavior, we should expect the stock to fluctuate by about least $7.15 over the course of a year.

Figure 3: Stock price history: close, high, low

Corning’s stock has traded at a volatile price-earnings (P/E) multiple over the last decade, averaging 11.6 over the last 10 years, 12.8 over the last five years, and 13.0 over the last three years. The company is trading at 9.0 times trailing 12-month earnings per share and 16.8 times expected future earnings.

For determining an estimated target P/E multiple, the first thing we like to do is eliminate any outliers from the historical data series. This includes abnormal P/Es that are not reflective of the normal operations of the firm, and this could be the result of abnormal growth or significant one-time nonrecurring charges/gains. In the case of Corning, we are going to remove the 2008 multiple as well as most multiples prior to 2005. The next thing we like to do is to run an optimization procedure that reveals which P/E multiple yielded the best forecasting accuracy over the evaluation period. If in our judgment this multiple continues to accurately portray the earnings and cash generating power of the company as well as the growth and risk characteristics of the firm, then we will use this multiple as our target multiple. If not, we will adjust the multiple upward or downward accordingly.

The figure below presents the historical P/E profile for Corning. We will utilize a target P/E multiple of 12.5 times which reasonably characterizes the risk-return attributes of the company's stock. This multiple represents an expansion of 38.9% relative to the current multiple. It also represents a contraction of -4.0%, a contraction of -2.2% and an expansion of 8.1% relative to the three-year, five-year and 10-year average P/E multiples.

Figure 4: Historical P/E multiple and target point of reversion

Setting a target price and valuation range

We selected a target P/E multiple of 12.5x. To determine a price target five years out, we then multiply this by our EPS estimate. EPS are estimated to reach $2.61 in five years giving us a target price of $32.60. This price is higher than its current price and is more in line with where it traded in 1999 and 2000. Nonetheless, to properly judge to what extent the stock may be under or overvalued, we need to determine a fair-value range within which we expect the stock to trade. To do this we rely on the trend-adjusted average annual trading range for the stock, which from the analysis above we know is $7.15. This means that, given our target price estimate, we expect the stock to trade naturally, and fairly, between $29.02 and $36.17. The result of this is that when the stock is trading below $29.02 it is in the Buy Zone and when the stock trades above $36.17 it is in the Sell Zone. Currently the stock is in the Buy Zone.

Conclusion

So what return can we expect for holding Corning's stock? Well, we now know we can expect stock price appreciation of 18.9%. We can also expect to earn dividend income of about $2.70 over the evaluation period. Added to our price estimate, this means we could earn a compound annual rate of return of 5.2%, provided our estimates prove accurate. All in all, we are happy with this company; it offers acceptable return potential to qualify for investment. We recommend buying it below $29 and selling at $36.

Disclosure: We do not hold any positions in Corning.

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About the author:

Daniel Seens
SEENSCO, a Canadian Corporation founded by Daniel Seens, CFA, is an investment research firm located in Ottawa, Ontario. Our Safety-First approach to identifying and evaluating companies helps investors to protect their principal and generate exceptional rates of return. For a 7-day free trial please visit our website at www.seensco.com.

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