Calling quarters is tricky business. We don’t have even a near-perfect track record of doing that with Corning. But we like the setup for GLW in 2018 based on our view of the fundamentals:
The primary BEAR case concerns:
- Investors are concerned about excess display glass inventory that may result from the LCD Panel wars at some point in 2018
- Investors are concerned about the optics of an F/X peg-related, non-GAAP revenue change that will reduce forward Street revenue estimates
- Investors are wary that Corning’s process of excess cash return has now netted a neutral to slightly net debt balance sheet, and keeping the promised rate of cash return will require an inflection in cash generation or an indebted balance sheet
- Investors are concerned that weakness in the Apple supply chain will significantly slow the growth of Gorilla Glass and reduce Street estimates
The BULL case:
- We think expectations around the display side of the business remain too dire. Glass capex remains near maintenance levels, and we believe supply growth from technology slowed from d-d% to s-d% in 2017. Panel capacity wars may have the impact of lowering panel prices, which more recently have driven incremental TV sell-through, a net positive to glass. Supply growth in panels is correlated to higher glass display revenue. And while the pace of glass price improvements has been glacial, it is still improving. Finally, we continue to model that the end market is approaching the natural replacement period for peak new buyers of original FP TVs in the 2009-2011 period.
- For the first time since 2004, Optical became the largest revenue segment for Corning in 2Q17. We think this is a big deal as the topline will now be incrementally driven by a revenue growth category, rather than a category that has declined (display). The impact on forward revenue growth will get a 2x boost entering 2018 with the integration of the 3COM acquisition (+400m revenue) and the reset (downward) of Display on the F/X peg adjustment. The Optical cycle tends to move in fits and starts, so we are modeling some unevenness in the quarterly y/y growth rate (esp. 1Q18). But overall the direction is being driven by the long term replacement of copper, which in the medium term is accelerated by enterprise data center technology changes, new metro optical architectures, as well as speed roadmaps and competition among ISPs.
Valuation: Bears call out Corning as an overvalued, low growth, low quality cyclical. It is hard to argue that it is cheap on traditional metrics, especially on EV/FCF, which is our go-to for mature companies. Either the company needs to deliver improving FCF, or deliver better revenue growth. We think a brighter revenue growth outlook comes in 2018 followed by a much improved FCF outlook in 2019. If we are right about better than expected growth in Display in 2018, as well as ongoing growth in Optical in 2018-2019, followed by Corning delivering FCF from the higher revenue base in 2019, then we continue to see a $45-50 ~12-month upside opportunity (40-45%) based on FCF in the $2b range. In the meantime, a weak quarter or weak FCF setup may see a retrench in the 10-15% range on LTM FCF.
