Ah, how wonderful it must be to supply the fast-growing smartphone and tablet industries and, even better, to devise a key component that merits its own trademarked name – such as Gorilla Glass, an invention that tripled its sales in 2011.
So what are we to make of the disconnect between the success of Gorilla Glass in the marketplace and the apparently bargain-basement valuation of Corning Inc. , its creator? The company, which posted top-line growth of nearly 20 per cent last year, trades at only seven times trailing earnings. Its deep cash hoard and generous dividend would seem to make it an obvious candidate for value investors who rarely get a taste of sexy technology stocks.
Yet Corning’s fourth-quarter results, released Wednesday, are salted with evidence that the company’s 2012 will be a choppy one. And that means investors who buy in at today’s depressed prices may find themselves waiting a long time for gains.
Gorilla Glass, the thin, light but tough glass that covers many smartphone, tablet and TV screens, is the company’s glamour offering. However, the bulk of the company’s sales (40 per cent in 2011) and profit (90 per cent) comes from its Display Technologies segment, which produces glass for LCD televisions and similar products.
It is there where trouble lies, with the company’s Wednesday earnings release fulfilling management’s warnings from November that it faces new challenges. A major South Korean customer of the company’s LCD television glass failed to buy its contracted amount of product in the fourth quarter. At the same time, Corning cut prices to combat oversupply in the market. All told, the segment’s sales declined 4 per cent from the previous quarter and gained just 4 per cent from 2010’s fourth quarter.
Corning’s chief financial officer, James Flaws, said Wednesday that price declines for its LCD products will be “significant” in the first quarter, just as they were in the fourth, and the company expects “significant double-digit price declines over the cumulative two-quarter period.”
Analyst Jagadish Iyer of Piper Jaffray, who initiated coverage on Corning stock in late December with a “neutral” rating and $13 (U.S.) price target (roughly Wednesday’s closing price), believes the company’s gross margins in the Display Technologies segment will undergo a “structural transformation,” dropping by eight full percentage points this year.
Corning is one of just three major players of LCD glass and, as a result, has felt little pricing pressure so far, Mr. Iyer notes. Glass prices have dropped at only half the rate of the wholesale price of flat-panel televisions – but that is about to change. “LCD glass suppliers have been enjoying healthy margins while their customers are struggling to make a profit … we see a structural shift in pricing power as the profitability of LCD glass suppliers stands out among the various participants in the value chain.”
These challenges threaten to overshadow the success of Gorilla Glass. And Corning’s problems don’t end there. It says lower worldwide demand for its customers’ tablet computers in the fourth quarter caused a decline from the previous quarter in Gorilla Glass sales. And the Specialty Materials segment, of which Gorilla Glass is just a part, contributes just 15 per cent of the company’s sales. (A restructuring charge saw the segment post a 2011 loss.)
While Corning’s glass has been used in Apple’s wildly popular devices, the secrecy over just who is a current supplier to the company makes it unclear how much of the product is currently going in to iPhones and iPads. Corning’s comments about fourth-quarter tablet demand seem to refer to devices from Samsung and Research In Motion, “which have seen limited success thus far,” says Evercore Partners analyst Alkesh Shah.
Is Corning more of a value trap than a value play, then? There’s a lot to recommend it: The forward multiple of around 10 is half Corning’s pre-recession levels, which also coincided with the pre-tablet time. With nearly $2.27 in cash per share, Corning’s business can be had for about $10, or even less than the multiple suggests. A recent dividend increase has pushed the yield above 2 per cent, and the company has announced an aggressive share buyback.
The answer, in the near term, depends on how well management’s pessimistic comments successfully reset the bar lower for 2012. It is the prospect of more cracks in the Corning growth story that is the real 800-pound gorilla.
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