Corning's Always-Frustrating Mix Of Opportunity And Risk

By Stephen D. Simpson, CFA | August 20, 2013 AAA

I will always have a soft spot for companies like Corning (NYSE:GLW). I'm a science geek at heart, and what Corning has accomplished time and time again in materials science is impressive to say the very least. But then there's the other side of the equation – brutal competition and capital spending cycles that create boom/bust cash flows and returns on capital. Although I do see some risks to the handset and TV markets, and the free cash flow model doesn't scream “cheap”, I wouldn't bet against this stock for the long term.

Can Notebooks Recharge The Gorilla?
Corning offered pretty lackluster guidance for Gorilla Glass volume with its second quarter earnings, and it does look like the high-end handset market is slowing for OEMs like Apple (Nasdaq:AAPL). Although Corning is still well ahead of competitors like Asahi Glass in the cover glass market, a slower underlying market is something that Corning really can't do much to change.

That could make the adoption of touch notebooks incrementally more significant to the company's near- or intermediate-term growth outlook. This market has yet to really take off (and I have my doubts as to whether it ever will), but notebook OEMs and companies like Microsoft (Nasdaq:MSFT) continue to support the concept pretty heavily. If that demand does materialize, it should be a good opportunity for Corning to offset any handset sluggishness for Gorilla Glass.

How Much Will OLED Impact The TV Display Business?
One of the larger bearish concerns about Corning's future is the impact that OLED may have on the company's TV business. OLED TVs won't require the same outer glass piece, and that ostensibly represents a sizable potential decline in volume for Corning. On the other hand, OLED TVs aren't really going to appear in volume before 2015 and Corning still has the opportunity to play a meaningful role with substrates like the new Lotus XT product.

It's also worth noting that OLED TVs are going to be expensive initially and color balance and lifespan still need to be improved before they're truly viable mass-market products.

SEE: 3 Industry-Impacting Innovations On The Horizon

Innovation Could Offset Risks
Serial innovation has always served Corning well. LCDs came in to pick up the slack as optical fiber demand waned, and Gorilla Glass in handsets has helped offset the pressures in LCD. With that in mind, I do believe Corning will be able to find additional growth opportunities in the future.

Lotus XT is a second-gen glass substrate for high-performance displays and the improved thermal qualities and stability should improve yields and costs for display manufacturers. Likewise, this new product offers 75% better pitch variation (pitch variation refers to the movement of transistors, liquid crystal material, and glass from sheet to sheet during processing), which improves yields and costs for display makers. Given that margins for display makers like AU Optronics (NYSE:AUO) are always competed down to razor-thin levels, yield and cost enhancement is very attractive.

Corning also has recently introduced Willow – a flexible substrate that can enable bendable or wrap-around devices.

I'm also intrigued by the company's recent investment in View, Inc. View is developing dynamic exterior window glass that can change tint in response to user input or environmental circumstances. What that means in real life is that the glass can go clear when it's cold (letting in sunlight to warm a building) and darken when it's warm to limit sunlight and keep the building interior cooler. I've seen estimates that this could reduce HVAC energy consumption by 20% to 25%, and that could make this product a real winner in the architectural glass market.

The Bottom Line
As I said in the intro, Corning is a tricky stock from a cash flow perspective. While I do believe that Corning has reached a point where it no longer needs massive capex spending to support revenue growth (allowing for sustained free cash flow margins in the teens), the extent of that revenue growth seems to be up in the air. It's going to take at least 6% compound annual revenue growth for Corning to merit a higher stock price from today, and while that looks modest relative to the trailing growth rate of over 11%, the risks to the handset and TV businesses offer some caution. At the same time, forecast EBITDA growth doesn't imply much undervaluation on an EV/EBITDA basis, though the ROE/PBV valuation looks a little more appealing.

I'm not going to suggest that valuation doesn't matter, but I would observe that Corning has a history of generating growth from businesses that many analysts never even thought about three or four years down the line. So while I'd prefer to pick up these shares after a pullback, I wouldn't be surprised if these shares are higher (and by a worthwhile amount) in another year or two.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

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