Corning: This Glass is Far From Brittle

11 minutes

corning

One of the first stocks I purchased using my new found value investing philosophies was Corning (GLW). It was the perfect vehicle for value investing with a low P/E, extremely low debt, and a great balance sheet. When I discovered the company in my weekly screening process, it jumped out +99at me as a possible candidate, and as I did more investigation, it quickly became apparent that this “boring glass company” could be the right fit.

As I dug into it more, I thought this would make Benjamin Graham proud, and were the perfect vehicle for my further exploration of the principles that make value investing so great. My valuations of the company at the time of my first purchase in 2012 still hold up today and is such a great buy for long-term investors.

There a lot of great things going on with this company that we will dig into further and the continuing dividend and share buybacks have added even more value to the shareholders.

Business Overview

Corning can trace their beginnings to a glass factory established in 1851. Talk about longevity; they have been a leader in specialty glass for more than 165 years.

They are based out of Corning, New York and currently have approximately 40,000 people employed with them worldwide, speaking of global they have plants in 17 countries.

Corning offers investors five reportable segments that the business is broken up into.

They are:

  • Display Technologies – which manufactures glass substrates for liquid crystal displays or LCDs that are used primarily in TVs, computers, and notebooks. This segment comprises 34% of Corning’s sales for 2016.
  • Optical Communications – This segment produces optical fiber, cable, and connectivity solutions, and is broken up into two main product groupings – carrier networks and enterprise networks. Also, this segment contributes to consumer electronic devices or cell phones. This segment provides 32% of Corning’s sales in 2016
  • Environmental Technologies – The focus of this segment is ceramic substrates and filter products for emissions controls in cars. This segment contributes 11% of Corning’s sales in 2016.
  • Specialty Materials Segment – This segment produces among other things glass ceramics used in display optics and semiconductor optics. The main claim to fame is the cover glass known as Corning Gorilla Glass. This segment contributes approximately 12% of sales for 2016.
  • Life Sciences Segment – The primary focus of this segment is scientific laboratory products such as plastic vessels, specialty surfaces, and media. Most of us are probably familiar with the PYREX beakers from our high school chemistry class; Corning made them. This segment contributes approximately 9% of Corning’s sales for 2016

Two of the main products that Corning produces are LCD glass and Corning Gorilla Glass. Let’s take a little deeper dive into the both of them.

LCD – This stands for liquid crystal displays that are used primarily in televisions and computer screens. Corning is a leader in glass making, and they have created several technologies that allow them to build flat glass. That might sound like a duh, but substrate flatness is critical in the production of panels for LCD TVs. Any deviations from flatness can create distortions, and nobody wants to watch the Super Bowl through distortions.

Corning has created a proprietary fusion process where the glass is formed in air and then drawn down to form an incredibly flat piece of glass with very precise thickness controls. To see a video of this creation, it is amazing to see.

They continue to push the envelope on creating thinner, stronger and more durable glass, which has more and more applications. Corning has created four LCD types of glass utilizing them in many different applications. They are:

  • Eagle XG, the industry’s first LCD glass substrate that is free of heavy metals;
  • Eagle XG Slim Glass, a line of thin glass substrates that enables lighter-weight portable devices and thinner televisions and monitors;
  • Corning Willow Glass, the ultra-thin flexible glass for the next-generation consumer electronic technologies;
  • The family of Corning Lotus Glass, this high-performance glass is used in LCD, as well as OLED which allows for brighter, more energy-efficient displays with high resolutions.

Corning glass is made all over the world. Corning is a little different in how they handle their manufacturing, in that they build plants to supply their customers where they are as opposed to production in one location and shipping all around the world. Because of this, they have facilities in South Korean, Japan, Taiwan and China which allows them to service their customers directly.

The net sales for the Display Technologies segment were up 5% or $152 million compared to the same period in 2015. The increase in sales driven by the strengthening of the Japanese yen and a mid-single-digit percentage volume increase driven by our need for larger TV screens. Partially increasing the offset by the LCD glass price declines which were slightly higher than 10%. We will discuss this a little more in the risk section.

Projections for 2017 in regards to LCD are that they expect retail TV units to be flat, but with a growth of screens by 1.5 inches, which will contribute 4% to 5% to the end market growth. They also think that in IT, the units sold will be flat but larger screen sizes. Which they believe will not lead to any increase in the market. Also, they feel that they have healthy inventory levels and expect their demand to be up in the mid-single digits, as the demand for LCD continues to decline Corning has begun to convert some of their manufacturing to the adoption of smartphone applications.

They also expect that the price declines of 2017 will be less than was seen in 2016, which they think will be the smallest declines in the last five years. They expect that Q1 of 2017 will be more moderate and very similar to the drop in 2016, which was the best result in five years. Remember that Q1 is typically the quarter with the largest decline because that is when annual supply agreements were final.

Gorilla Glass – Arguably the most famous product that Corning produces. It is a high-technology, incredibly tough glass that is used for just about everything now. From windshields on cars to your cell phone, computers, markerboards, and interior architecture. Gorilla Glass is extremely durable and offers distinct advantages over other materials.

The glass is chemically strengthened through an ion exchange that helps create an “armor,” making it very resistant to damage, i.e., dropping your phone. It is also incredibly thin and retains its performance advantage over other cover materials. Because of Corning’s proprietary fusion process, it is incredibly clean, smooth, flat and has amazing optical clarity. All these features make this glass the perfect cover material for touch screens.

Net sales for the Specialty Materials segment improved 2% for 2016, or $17 million. Specialty Materials was driven by an increase in sales of Corning Gorilla Glass 5, although the first three-quarters of 2016 saw lower sales, there was a surge in the fourth quarter due to the rapid adoption of Corning Gorilla Glass 5.

In addition to the all the current applications, they are also seeing more glass used per device, with handset antenna requirements to support increasing data rates and the desire for wireless charging; glass is becoming the preferred material in more places on the phone. Greater use of Corning Gorilla Glass, of course, is great news for Corning and all their products.

Business Analysis

2016 was a great year for Corning, and they rewarded their shareholders. In 2016 Corning distributed approximately $6 billion in share repurchases and dividends. There was an approval for a $4 billion share repurchase in December and annual dividend increases of 12.5%, with an additional increase of 14.8 in February 2017.

In 2016 they realigned their interest with Dow Corning which created $4.8 billion in cash for the company. Additionally, they also strengthened their Optical Communications with two acquisitions.

Since 2006 there has been a steady upward motion to the company’s revenue. It has increased by 37.59% over the last ten years. Corning attributed it to their continuing increased performance of their different segments and all the specialty glass that they can offer their customers. With the continued development of Corning Gorilla Glass and its implementation into more applications, this will continue to drive the revenue higher.

As you can see the company has had a substantial increase in its earnings in the last five years. The significant increase of 2016 Corning attributes to the $2.7 billion non-taxable gain from the alignment of ownership interest in Dow Corning and a $105 million positive tax adjustment, wish I could get one of those. Additionally, there were increases in their returns in the pension assets.

As I was creating this article the latest earnings report for first quarter 2017 was released, and there was more good news in regards to net sales and earnings. According to Wendell Weeks, CEO

“First quarter sales were up 14% over last year, with growth in all businesses. EPS was $0.39, up 39% year-over-year. For the second quarter, we expect to sustain our momentum with year-over-year sales and EPS growth once again.”

So, the momentum that they created continues into the first quarter of 2017 and is likely to continue with the expansion of the use of their many products in a diverse lineup of placements.

Not all was rosy was last year as they continued to see a decline in the Display Technologies segment which was down 15% for 2016,  driven by the continuing softening in the prices for LCD glass.

To confront this decline, Corning has implemented several strategies to start to pivot away from the LCD portion of their business, among them is the use of their glass in the optical segment.

Recently there was an announcement of a deal with Verizon of a 3-year minimum purchase of $1.05 billion with Corning to provide fiber optic cable and associated hardware to Verizon.

With their new plans to build a global headquarters for optical communications in North Carolina, as well as an expansion of the manufacturing capacity there as well, they have embraced this avenue of growth and are pushing ahead.

If you would like to read more about this deal and it’s ramifications, please read more here, as Willow Street Investments does an excellent job reporting on events with Corning.

Finally, with Corning being an international company, they have many challenges when it comes to dealing with currency exchange rates and one of the ways that they combat this problem is the use of currency hedges. Since its inception, Corning has received $1.4 billion in cash under their hedge contracts. These funds offset much of the yen-related fluctuations in Display’s earnings.

Much of the difference between their GAAP and core results are a consequence of the non-cash mark-to-market adjustments. GAAP account required earnings translation hedges settling in future periods to be marked-to-market and recorded at their current value in the current quarter, even though the contracts won’t settle in the current quarter.

As an example during the first quarter of 2017, the yen strengthened which reduced the value of the hedge contracts, causing a GAAP loss of $326 million when the contracts were marked to market as required. Though this occurred, it has no bearing on Corning’s cash flow.

They are very pleased with the results of the hedging program, and it helps the reduce the yen-related fluctuations in Display’s earnings, and it helps mitigate the risks of the weakening yen.

Key Risks

Corning does have a few risks that need addressing, so you are aware of them.

First, would be their use of raw materials. For all the glitz and glam of the company, they are after all a “boring” glass company, with Corning lumped into the technology sector with their reliance on those customers as purchasers of their products.

Certain key materials are currently sole-sourced, and this requires them to extremely diligent about monitoring this. Several of the materials are from one supplier only, and any interruption in these materials could have a substantial impact on their sales.

Next risk would be the concentrated customer base. Consider this chart from the 10-k 2016.

Chart courtesy of Intrinsic Value Formula

As you can see from the chart, the concentration is in several areas, which could be potentially hazardous to the company’s financial health.

Another potential risk is the effect of currency fluctuations to Corning, being that they are an international company they are extremely sensitive to these variations. To hedge against this potential problem, Corning utilizes over the counter derivatives to protect its currency exposure. If these derivatives don’t perform as expected, they could expose Corning to significant potential losses, based on the fluctuations of the exchange.

And of course, there are the continuing softness in the price of LCD glass, this ongoing downside of the largest segment of the company could be a drag if this cycle doesn’t change. Corning has done a fantastic job diversifying its product mix and will continue to do so for many years to come.

Dividend

Dividends are one of the fantastic ways that Corning demonstrates that it is a shareholder friendly company.

Chart courtesy of Intrinsic Value Formula

As you can see from the chart, they have been paying a rising dividend for the last ten years, and according to their strategic plans, they will continue to grow the dividend to reward their shareholders for their patience.

Another factor to look at is their payout ratio to see if this continued growth in dividends is sustainable. And the average for the last five years is 33.45%, which makes it quite durable. The dividend yield is currently sitting at 1.96%, but with the share buybacks they have done and are committing to in the future, there is plenty of value provided.

I would say that Corning’s dividend is extremely sustainable with a payout ratio that low, that means they have ways to allocate their capital in a fashion to continue to grow the company and pay a rising dividend like they have for the last ten years

Valuation

Corning, despite its excellent financial performance the last few years has an exceptionally low P/E ratio of 7.80 for TTM and a five-year average of 15.13.

If you do a quick intrinsic valuation of the company using some formulas these are the values I come up with.

  • Graham Formula = $32.01
  • Discounted Cash Flow =$34.14

Both of these calculations show the company currently undervalued by approximately 17%. While this is not a huge margin of safety, there is room here to buy if the stock dips for any reason.

The recent good news from the latest earnings report gave the company a boost of over 3% on that day, so the intrinsic value has crept up recently.

The company ended the first quarter with $4.9 billion on the balance sheet and created $341 million in free cash flow from operations, which is up from last year.

The expected returns of the company for the coming year:

  • Expected growth = 9.5%
  • Dividend Yield = 1.9%

Which would give us an expected return of 11.4%, not too shabby?

Finally, a note about the debt of the company, the debt to equity ratio for the TTM is 0.22 and the average for the last five years is 0.15, which is outstanding.

Final Thoughts

As I mentioned earlier, this was one of the first company’s that I put through the Ben Graham valuation method, and I think the analysis still stands up.

They have some exciting growth prospects, with the development of the optical segment and the growing adoption of the Corning Gorilla Glass.

One of the things I like about the company is that they have been around for 165 years and they have learned how to adapt and react to the trends so that they remain relevant. Corning has also realized that technology can help improve their business and have adopted that reality and have created such amazing products.

Their, R&D budget rivals some technology companies and has helped them stay at the forefront of their field.

Although they typically get lumped with the technology sector, they fall into the manufacturing sector. After all, Corning is a “boring” glass company, but they utilized the latest in technology to improve and create better glass and uses for their glass. The evolution of smart glass is to me revolutionary, with all the uses never considered when I was younger.

My earlier analysis has stood up, and I think that Corning is still a great buy and I will continue to add to my position. This company is far from brittle and has the growth potential to rise even higher, with the rising dividend, low debt and tons of cash on the balance sheet this is a company poised to continue to do great things.

That will do it for this week.

As always thank you for taking the time to read this article, and I hope you found it of value to you.

What are your thoughts on Corning? Would you buy? Let me know your thoughts in the comments.

Take care,

Dave

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