A Severe Overreaction

 | Oct 30, 2012 | 9:30 AM EDT  | Comments
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Corning (GLW), which closed Friday at $11.82, reported solid overall results for the third quarter last week. However, the stock was punished for cautious management comments about the current business environment -- ones that weren't dissimilar to those of many other companies -- and for some confusion about its core LCD-glass business. We believe the market severely overreacted, and that valuation is now just too compelling to resist.

For the quarter, Corning reported a $0.02 earnings beat and slightly better revenue, mainly due to better margins from its specialty Gorilla Glass product and to the above-plan results in the TV-glass business. Gorilla has been a home run; television-unit volume is down, but screen size has increased and a transition to thinner glass has both carried higher margins.

Its other operations -- environmental, telecom and life sciences -- are all good businesses. However, they are cyclical and have trended with the sluggish economy. We actually believe management provided overly cautious expectations for these businesses.

To complicate matters for investors, the company announced a new pricing plan for the LCD-glass business. Corning has more than 50% share of this market worldwide, against just two primary competitors.

As the market for flat-screen TVs has matured, some smaller players have tried to lower prices in order to steal share, and that has hurt all players for a few quarters. As this glass market has since normalized, Corning has signed agreements with nearly all of its customers in order to ensure relative share with the price set by "the market." While management believes the market will respond rationally, and thus benefit all manufacturers, investors have initially feared that this structure will be the start of another price war. We think not, since the new structure basically insures Corning's market share, making overly aggressive price reductions a self-inflicted wound for the company's competitors.

Looking at the stock, we believe the valuation is table-pounding. Corning trades at just 9.3x estimated 2012 earnings of $1.27 per share. Even with the new uncertainty in the glass business, the company's profit for next year is expected to grow more than 7% to $1.37, implying an 8.6x multiple on 2013 earnings. The stock currently trades at about a 20% discount to book value of $14.73 per share, and the strong balance sheet features $3 billion of cash net of all debt.

Given these attribute, Corning's earnings multiples are exceptionally low. Further disconnecting the stock price from an appropriate valuation is the fact that the company's dividend yield is now at 3% following a recent 20% increase. The company is also completing a $1.5 billion share repurchase, and a new authorization should be forthcoming early next year.

We therefore believe Corning is a compelling value here. All the negatives are priced in, with no credit for the many positive developments: The TV glass business has good potential upside from the new contract structure, Gorilla is a certifiable hit and ancillary businesses should rebound as the global economy follows suit. Finally, management is increasingly shareholder-friendly while still maintaining the company's superior financial strength.

Bottom line: Corning is a hidden tech-stock jewel with excellent management, great financials and a compelling valuation. A mere common-sense return to book value should make for a 25% move in the next six to 12 months -- and, at those levels, we would still undervalue Corning!

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