Short Stop: This Glass Will Break Your Heart

 | Sep 20, 2011 | 10:00 AM EDT
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It seems Corning (GLW) should be a perfect stock. The company is in the sweet spot of some of the fasted selling products on the planet -- tablet computers, laptops, LCD televisions, cellular handsets, and fiber optics. You name it. It's one blockbuster after another. However, the stock does nothing but go down. Year to date, the stock is down 30%, and it's off 43% from its 52-week high. What gives?

Corning is universally loved. Ask any market pro and they'll tell you how high the stock will go. "Yeah, Maria -- we've got a $19 price target and a long-term price target of $24. They make the glass that goes in all that geeky stuff you see on TV. The stock is wicked cheap. It's only trading at 7x our estimates. We've got a Mega Super Buy on the stock! Woo-hoo!"

But Corning is one of those names that always break your heart. It works for a while, and then -- it doesn't. It goes higher for a year, two or even three -- and then breaks down. It never gets back to the highs. This type of pattern typically happens with commodity suppliers in the tech space. At the beginning of the trend it is straight up as the company rushes to meet demand.

But, after a few years, the company has built more than enough factories to satisfy demand. Competition increases. As unit volumes explode for handsets, tablets and LCD TVs, the component supplies typically get crushed, with demand for ever-larger discounts coming from larger companies further up the chain. The commodity suppliers have to scramble to maintain margins. Each year it gets harder and harder to maintain margins.

Even though Corning will have record revenue of $8 billion, next year's consensus analyst estimate of $8.7 billion points to dramatically slower revenue growth. Also, margins expansion slowed due to slower demand for LCD glass (40% of revenue), and that's especially in the first half of fiscal 2011. Capacity utilization fell amid inventory build in the supply chain. On just a 4% drop in display revenue, gross margins fell almost 100 basis points. Earnings per share are poised to slow even further as the company has worked off a deferred tax allowance, which has kept Corning's tax rate negative for the last few years. As the tax rate returns to a more normal level, the EPS growth rate will slow.

Look, I know everybody loves the stock. The company expects a strong second half -- and maybe it will happen, and I'll be wrong. But I doubt it. If unit volumes of LCD televisions don't pick up meaningfully in Asia, I believe gross margins will remain under pressure.

Tech stocks don't work when margins are getting squeezed. Investors tend to fall in love with the suppliers in the middle of the supply chain, but it's always those companies that end up with the commodity products. Now, you can argue that Corning's glass is special. It's patented. It's the best. It's top secret. Yada, yada, yada. But, at the end of the day, it's all just melted beach sand.



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