Tuesday, February 23, 2010

Corning (NYSE:GLW): When Things Are Too Good to Last, They Don't - Oppenheimer

Oppenheimer is making a significant negative call on Corning (NYSE:GLW) downgrading the name to Perform from Outperform and removing their $21 price target. The firm is also downgrading Au Optronics (NYSE:AUO) to Underperform from Perform.

Oppenheimer notes their analysis suggests that the LCD panel industry is in the final stages of a prolonged rebuild cycle that has helped significantly boost LCD panel demand over the last 9 months. With the cycle likely to peter out in the next couple of months, they believe LCD panel shipments will need to reset during 2Q to a lower level that is more closely aligned with underlying sell-through trends, particularly for TVs. If their analysis is correct, 1Q panel shipments are likely to represent the peak (or the near-peak) for 2010.

The industry participants likely to be most hurt by such a turn of events are the panel makers (such as AUO), whose prices and profitability can swing quickly and violently. Consensus estimates forecast that 1Q will represent trough earnings for LCD panel makers; Opco's analysis suggests 1Q may be as good as it gets in 2010.

The situation will likely be far less dire for LCD glass substrate makers. Corning and its small cadre of competitors have proven much more capable of maintaining pricing discipline through periods of volatility, and will likely be able to do so again, especially in the near term, when any pullback in demand can be used to rebuild the glassmakers' depleted inventories. Firm ntoes they are therefore not particularly worried about the risk of outsized pricing pressure or margin erosion at Corning. They are concerned, however, that Street estimates seem to ignore the likely 2010 seasonality and that current 2010 EPS consensus likely represents a best-case scenario.

Oppenheimer notes they recognize that Corning remains attractive in terms of valuation, trading at only 11x their below-consensus $1.64 and only 12x their worst-case FY10E scenario of $1.53. Still, they'd rather move to the sidelines until such time as consensus estimates and sentiment provide Corning a better chance of delivering positive rather than negative surprises.

- Firm estimates LCD TV panel shipments will reach 50M units in 1Q10, an unsustainable rate, in their view. Opco's above-consensus sell-through estimate of 176M TV units in 2010 implies that total LCD TV panel shipments will likely reach only 190-195M annual units, including the 15-20 million units attributable to channel expansion. Upside to their estimates will not be easy to achieve.

- Two factors appear to be driving 1Q10 LCD shipments above the underlying trendline: backfill of channel inventories, which were depleted following a better than expected 4Q09, and the last stages of channel expansion in China, where LCDs are now making their way into lower tier cities and regions.

- Oppenheimer notes they recognize IT panel demand could surprise to the upside during 2010. But with IT now representing only ~30% of total panel area, upside is unlikely to have a material impact on overall market dynamics. Under a best-case scenario (10% monitor growth and 28% notebook growth), total glass demand would exceed their current glass estimates by only 2% (or 60M ft^2).

Opco's GLW estimates, which were already slightly below consensus, are unchanged. They are cutting their AUO FY10E EPS to NT$0.54 from NT$1.95. Firm believes AUO consensus estimates, which project 1Q10 as the annual trough, rather than the peak, are subject to significant revisions.

Notablecalls: Oppenheimer's Yair Reiner & his people have done a pretty good job covering Corning over the past year. So, I would definitely take into account what they are saying.

The sector got hit yesterday after several analysts said LCD sales in China were weaker than expected over the Chinese New Year. So the downgrade itself isn't too surprising. It looked like Opco was looking for a reason to downgrade the names already back in January.

Both stocks will trade down today but I suspect AUO will be the hardest hit of the two.

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