2023-06-08 17:43:17 ET
Summary
- Corning stock offers a solid 3.5% dividend yield and above 20% upside potential, outweighing headwinds and risks.
- The company is expected to see sequential revenue growth in the upcoming earnings, marking a positive pivot.
- Risks to consider include technological risks, supply-chain risks, foreign exchange risks, and geopolitical risks.
Investment thesis
Corning ( GLW ) stock currently trades about 50% lower than its all-time highs. Recent weakness was due to declining revenue together with shrinking margins over the last three quarters. The company experiences severe headwinds related to a harsh macroeconomic environment. But I believe these challenges to be temporary and not secular. The stock offers a solid 3.5% dividend yield and above 20% upside potential. These benefits significantly outweigh the headwinds and risks.
Company information
Corning traces its origins to a glass business established in 1851. Nowadays, GLW is a leading global supplier of precision glass for liquid crystal displays and a leader in the optical fiber and cable market. The company's fiscal year ends on December 31.
According to the latest 10-K report , Corning manufactures products at 124 plants in 15 countries and operates in five reportable segments: Optical Communications, Display Technologies, Specialty Materials, Environmental Technologies, and Life Sciences. The company's revenue streams are relatively diversified; the largest segment, Optical Communications, represents 35% of the total.
The company trades its products worldwide, and sales outside North America represented more than 60% in FY 2022. About 30% of Corning's revenues are generated in China.
Financials
Over the past decade, Corning demonstrated steady revenue growth of about 7%. Costs grew faster, though, making the gross margin decline from 43% to 34%. The same thing happened with operating profit, which also experienced a notable decline. Levered free cash flow ((FCF)) margin with stock-based compensation ((SBC)) deducted has been highly volatile over the decade and demonstrated a decline from 7.1% to 5.4% overall.
The company returns money to shareholders both via repurchases and dividends. Dividend consistency is impressive, with 12 consecutive years of dividend growth. Though, share repurchases declined over the past decade from billions to hundreds of millions per year. Apart from solid dividend consistency, GLW also has a high "A" Seeking Alpha Quant dividend yield rate. At the moment, the forward dividend yield is slightly above 3.5% which I consider very decent.
The balance sheet looks clean, with above $1 billion outstanding cash and moderate leverage metrics. The only thing which potentially can be called a red flag here is a large discrepancy between the current and quick ratios, meaning inventory represents a vast part of current assets. This is due to the softening demand across almost all end markets, and I believe it is temporary.
Seeking Alpha
If we narrow the P&L analysis to recent quarters, we can see that the company demonstrated three consecutive quarters of YoY revenue decline. GLW suffers from weakening demand across its end markets due to macroeconomic uncertainty. Gross and operating profits declined faster than the topline, meaning that margins were under hard pressure.
Headwinds of the few past quarters mainly comprised of higher raw materials costs and higher logistics expenditures. From the revenue side, GLW experienced macroeconomic challenges in display and mobile communications due to sharp weakness in smartphone sales in recent quarters . The management addressed these headwinds with select pricing hikes and improved productivity due to cost alignment.
All these measures are expected to lead to a sequential revenue growth for the upcoming earnings together with EPS expansion. Revenue is expected to grow about 3.5% sequentially. I like this fact and consider it important because three previous quarters demonstrated sequential decline in revenues. So it looks like a start of a positive pivot for me. The upcoming quarter's earnings are scheduled on July 27 and profitability metrics will be very important to watch.
Valuation
Year-to-date, GLW stock demonstrated a slight 2% decline in price. It means the stock substantially underperformed the broad market and technology sector ( XLK ). According to Seeking Alpha Quant , the stock has a decent "B" valuation grade, which might indicate the stock is undervalued. If we look at the multiples, they are currently mostly lower than the sector median and GLW's 5-year average valuation ratios.
Now let me simulate the discounted cash flow ((DCF)) model to determine the fair value of GLW business. GuruFocus suggests that Corning's WACC is approximately 9%, which I consider relevant as a discount rate. I have revenue consensus estimates available up to FY 2026, and for the years beyond I incorporate a very modest 4% revenue growth. Overall, my DCF projects a 4.8% revenue CAGR, two percentage points lower than the past decade's pace. For the FCF margin, I use the past decade's average, which is about 7.1%. I expect it to expand by 25 basis points each year and that it will peak at 10% in FY 2032 and beyond.
The DCF template returns me Corning's fair value at about $34 billion, which is more than 20% higher than the current market cap. Underlying assumptions are very conservative, so the margin of safety is massive at the current price level in my view.
To cross-check my DCF, I also want to add more conviction with the help of the discounted dividend model ((DDM)) valuation approach. Consensus estimates expect FY 2024 dividend to be at $1.19. I use a 6% expected dividend growth rate, a rounded-down 5-year EBITDA growth rate. The WACC is the same as for DCF at 9%.
Author's calculations
As you can see from the above calculations, based on DDM, the stock's fair value is close to $40. It means there is about a 25% upside potential for GLW stock.
Risks to consider
Corning offers innovative products to its addressable markets. That said, the company faces high technological risks. The fast-paced nature of technology poses a significant risk of products becoming obsolete. GLW's business is a complex production, meaning the company also faces supply-chain risks. These include disruptions like a lack of raw material availability, transportation delays, or potential bottlenecks in the manufacturing process. Failure to manage supply-chain risks efficiently can impact the company's ability to meet customer demand and keep its reputation high.
The company generates a significant part of its sales outside North America, meaning significant risks related to foreign exchange rates. Unfavorable fluctuations in exchange rates will negatively affect the company's financials - both from the revenue and costs sides. The management should ensure that proper hedging measures are taken to mitigate foreign exchange risks.
I also see geopolitical risk as high for Corning. The company generated approximately 30% of its FY 2022 revenues in China. We all know that geopolitical tensions are intensifying between this country and the U.S. Further escalation might lead to adverse consequences for the company's operations. This will ultimately undermine the financial performance.
Bottom line
Overall, I believe GLW's benefits to potential investors significantly outweigh the risks. I think so because headwinds seem to be temporary and not secular. The margin of safety is vast, according to my analysis. Moreover, a 3.5% dividend yield is not frequently found for a company that still hasn't reached the maturity stage of its business cycle. Therefore, I believe the stock is a strong buy for long-term investors ready to wait until the storm ends.
For further details see:
Why Corning Stock Is A Strong Buy