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Corning May Shatter Investors' Hopes

Post Time:Feb 20,2009Classify:Company NewsView:381

Amid the worst economic downturn since the Great Depression, some investors are far too eager to find cause for optimism. Corning (ticker: GLW), which makes glass for television sets, is a prime example.

Corning's shares have surged 30% in the past three months on hopes that growth will resume after a recent sharp quarterly decline. During that same period, the Dow Jones Industrial Average has fallen 1%.

What's more likely is that Corning shares will surrender much of their recent gains (even with the stock more than 60% below its 52-week high) as earnings estimates for the company fall further. Here's why.

While consumers continue to buy TVs, they're buying them on the cheap. Global flat-panel TV revenue fell 3% in the three months ended in December, the first decline for that product category ever, despite a 17% jump in the number of sets sold.

Corning's customers, the companies that make display panels for TVs, computer monitors and laptops, will respond to uncertain demand and falling prices by either limiting their glass purchases, to keep prices for panels high, or by ramping up production, leading to another panel glut and falling prices.

Neither scenario will make for big profits at Corning. The company's margins are tied both to the volume of glass it sells and to the price of the finished goods containing that glass.

"Panel makers are really struggling," says Paul Semenza, an analyst covering display technology at market research firm DisplaySearch. "They are asking themselves if they should increase production or raise prices" by keeping production low.

"Everyone is groping in the dark, wondering, what exactly will be the nature of TV demand this year?"

Corning stock trades at a forward four quarters' price-to-earnings multiple of 17.1 times, about its median for the last five years, and not far from the 21.7 times median of the last 10 years.

That 17.1 P/E ratio is 50% higher than the Standard & Poor's 500's multiple, which is not where a stock should be for a company selling a commodity in the midst of a consumer implosion.

Corning's total sales fell 30% in the fourth quarter, with the company's sales of glass for displays, the biggest single contributor to revenue at about 46% of sales, down 50%.

In response, Corning intends to cut nearly 3,500 jobs, or roughly 14% of its workforce. Going forward, Corning has set what it believes are reasonable expectations for 2009.

The company projects $5 billion in sales this year, down 15% from 2008. That's based on an expectation that its customers, including Sharp and others who use glass to make display panels for TVs and laptops and computer monitors, will start shipping more panels after six months of cutting back on production.

But Corning's had a bad track record of predicting what its customers will make -- not because the company isn't astute about its market, but because a market in recession is hard to gauge.

Early last year the company thought the TV industry would grow by 40% in the December quarter, but growth turned out to be half that much.

"I don't think we could have anticipated the September financial shocks and the subsequent traumatic impacts on consumer confidence in spending," said Corning's Chief Financial Officer Jim Flaws during the company's fourth-quarter conference call on Jan. 27.

While panel inventory is by all accounts tight, the state of demand for those panels in the form of finished TVs and computers is far less certain.

LCD TV sales are expected to rise 14% this year, to 120 million units worldwide. However, "This year more than ever, [panel and TV production] is so subject to consumer psychology," says Semenza.

On the computer side, expectations for laptops and monitors containing glass keep going lower.

Hewlett-Packard (HPQ), the world's No. 1 computer maker, on Wednesday reported sales of its personal computers fell 19%, year over year, in the January-ended quarter, worse than analysts expected.

In short, the PC market "is showing no signs of improvement," according to a note put out about HP on Thursday by UBS Securities analyst Maynard Um.

What happens in an uncertain demand environment is that Corning's customers either hold back on making more panels, in order to drive up prices, or they start building wildly, leading to declining prices.

The former scenario, where panel makers choose profit over production, seems the more likely, says Semenza.

"Panel makers are cautious," says Semenza. "Many panel makers are basically losing money on each TV panel they sell. And so they're all about getting back above cost" by keeping supplies limited.

To be sure, some bulls offer the notion that if Corning ends up selling less glass, it will spend less on factories and have more cash left over.

Not anytime soon, however. Despite cutting capital expenditures nearly in half for 2009, the bulk of Corning's capital expenditures will be made in the first half of this year, when profits are expected to keep falling. Even if Corning could keep profits roughly flat this quarter and next, real cash profit would be completely erased by those up-front capital expenditures.

So, cash won't be king at Corning the first half of this year.

Corning does have a relatively clean balance sheet, with about $2.8 billion in cash and short-term investments at the end of the fourth quarter, compared to $1.5 billion in long-term debt. Moreover, most of that debt doesn't come due until 2014.

But a clean balance sheet won't help the stock if earnings expectations continue to weaken. In the dot-com bust of 2001 to 2002, Corning shares continued to sink as earnings expectations fell. The stock only turned up in 2003 as the company emerged out of deep losses.

There'll be a time to buy Corning shares, and that will be when earnings estimates have bottomed and when earnings have fallen so far that year-over-year earnings growth becomes a virtual certainty.

Source: barrons.comAuthor: shangyi

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