Many investors are more hesitant than ever about Corning (GLW) after a continued decline in pricing and the release of a report indicating that inventories were actually more elevated than what some expected. 21 revisions to EPS estimates have now all gone down for a staggering net change of -17.3%. Even still, I remain confident about the attractive value play that can be found in this tech firm. Based on my multiples analysis, review of the fundamentals, and DCF model, I find that it will outperform Danaher (DHR).
From a multiples perspective, we have a tale of two different worlds. Corning is by far the cheaper of the two, trading well below historical levels while its competitor is at an irrational premium. Corning trades at a respective 7.8x and 9x past and forward earnings when it has historically hovered between 15x and 20x with a dividend yield of 2.2%. Danaher, on the other hand, trades at a respective 19.1x and 14.4x past and forward earnings. In light of the contrast, I believe the market will eventually close the discount. The Street currently rates Corning a "buy" versus a "strong buy" for Danaher.
At the recent fourth quarter earnings call, Corning's CFO, Jim Flaws, noted strong fundamentals that are being masked by investor fear over pricing trends:
Looking back at 2011, it was a year when the company achieved many milestones but encountered significant headwinds. From a financial standpoint, Corning had an outstanding year. In 2011, the company set records for sales, gross margin and operating income without specials. All of our businesses achieved increased sales year-over-year, sales of Corning Gorilla Glass almost tripled. We achieved our eighth year in a row of positive free cash flow, we maintained our very strong balance sheet, raised our dividend and initiated a sizable share repurchase program. We also brought significant new innovations to the market as our patient investments in research are paying off. Newer products, such as Lotus Glass for OLEDs and now a new, much thinner cover glass in Gorilla Glass 2 have been very well received by customers. We believe this is an outstanding list of achievements, despite less-than-robust growth in the developed economies around the world. However, it does not tell the entire story.
Fourth quarter results suffered from dramatic declines in price due largely to poor bottom-line momentum among panel makers. This trend is expected to continue over the next few quarters. But, perhaps miraculously, gross margins were meaningfully above consensus at 43.7%. Fiber & Cable further performed well with revenues of $252M even as Dow Corning's equity income experienced a 35% sequential decline. Management is getting more aggressive on capital allocation while reigning in capex. Moreover the firm has plenty to return with its solid free cash flow generation that is modeled to rise at least over the next two years.
Consensus estimates for Corning's EPS forecast that it will decline by 19.3% to $1.42 in 2012, grow by 7% in 2013, and then hold flat in 2014. Assuming a multiple of 12.5x - well below historical levels and that of Danaher - and a conservative 2013 EPS of $1.45, the rough intrinsic value of the stock is $18.13, implying 32% upside.
Danaher, on the other hand, will have to focus more on cleaning up its balance sheet following the takeover of Beckman Coulter. Its payout ratio is abysmal--accordingly, investors can benefit off of a likely capital allocation hike. The firm, however, is well exposed to EE/MI, and growth appears to be decelerating at a quicker speed than that of peers. While Danaher certainly merits a premium due to its record of execution, multiples are likely to contract given greater to healthcare where ROIC is lowest.
Consensus estimates for Danaher's EPS forecast that it will grow by 17% to $3.31 in 2012 and then by 11.2% and 12.8% in the following two years. Modeling a CAGR of 13.6% for EPS over the next three years and then discounting backwards by a WACC of 9% implies that the market has properly assessed Danaher's value.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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