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. With pricing more of a known variable, the company appears to be set to beat earnings expectations in the short term for several reasons:
1) 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. 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. Despite all these positive industry data points, consensus estimates for Corning’s Q3 have barely changed.
2) 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.
3) 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 is fails to take into account the larger context. While the stock has done well recently, it has still under-performed 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:
1) Large new business opportunities and diversification should help the stock’s price-to-earnings multiple.
2) Replacement demand and a housing recovery could drive an upturn in LCD TVs.
3) Windows 8 could drive an improvement in PC demand.
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. A few corporate insiders have bought stock at around this same price over the last several months.
I think the stock can re-rate to about 12x my 2013 EPS, which is modestly higher than the Street, or $17.50 or about 35% upside.
Ravee Mehta is a SumZero member and is the author of the recently published work "The Emotionally intelligent Investor: How Self-Awareness, Empathy and Intuition Drive Performance". Whereas the consensus opinion is that investing success comes from blocking out emotions and making purely rational decisions, the best money managers actually use their feelings. This book demystifies intuition with respect to investing and provides a method for building and safely harnessing helpful gut instincts.