Wednesday, August 25, 2010

Corning (NYSE:GLW): Time To Be Early; Upgrading to Outperform

Oppenheimer is upgrading Corning (NYSE:GLW) to Outperform from Perform and introducing a $20 price target.

Firm notes their upgrade doesn't mean that they think the inventory correction rattling through the LCD supply chain is over. The most likely scenario is that it will endure another one to three months. Still, if prior inventory corrections are any indicator, this is the time to turn positive on GLW's shares, when fear of downward revisions is peaking and when potential upside scenarios--Gorilla Glass, an accelerated TV replacement cycle, solar, etc.--lie forgotten in the weeds. Even after trimming their FY10-11 estimates to reflect a fairly grim industry view, GLW shares look severely undervalued at current levels and poised for recovery.

The dramatic compression in Corning’s multiple—to 7.6x, at last check—appears to reflect growing investor concern that the inventory correction sweeping through the LCD supply chain could lead to major downward revisions to Corning’s EPS estimates. Oppenheimer believes this concern is overdone and that even in a very bad scenario—we don’t say worst case, because there’s no limit to how bad things can get—Corning can earn approximately $1.89 per share next year.

While $1.89 is ~10% below the Street’s consensus, it’s probably a bit better than a nightmare scenario that the downdraft in GLW’s shares would seem to portend. EPS of $1.89 would still imply a current valuation of 8.3x, below Corning’s recent normalized trading range of 9x-14x and a 30% discount to the S&P average of 11.3x.

- Investors may be understandably nervous about stepping into GLW before the end of the inventory correction is in sight. But it pays to be early. During the last inventory correction, GLW's shares bottomed a month before panel prices found a floor, two months before estimates bottomed, and 3.5 months before industry fundamentals began improving.

- Because inventory cycles are driven by herd psychology as much as by supply and demand, it's tough to know when fear of shortage will swing into fear of glut, and then back again. The 2H09 inventory build overshot its mark in 1H10, and the current correction could err in the other direction.

- Slightly more predictable, however, is investors' ability to discount these inventory corrections. During the cycles of 2006 and 2008, it took investors approximately 4 months to fully discount the inventory correction and to become inured to incremental downward revisions. Approximately 4 months have passed since investors began to sniff a top to the current cycle.

Also worth noting: in each of the last two corrections, the bad news was digested and a sustained share recovery began (points 3 in the chart below) well before the Street had finished cutting estimates (points 4 in the chart below) and before improved LCD panel pricing had begun testifying to improved industry fundamentals (points 5 in the chart below).

In short, while Opco's call is almost certainly early from a fundamental point of view (insofar as industry fundamentals will take a bit longer to improve), it may not be too early from a stock point of view.

- Moreover, the current correction is likely to be much less severe than the prior one. Fear in the supply chain is not running nearly as high as in 2H08-1H09. And, unlike the last cycle, glass maker inventories are exceptionally low, which should mitigate the pressure to dump product.

Notablecalls: I'd say Yair Reiner from Oppenheimer carries weight in the space. He turned cautious on the LCD Panel space back in February, downgrading both GLW & AUO saying demand would peter out in Q1.

February 23: When Things Are Too Good to Last, They Don't

And now he is reversing his call.

This LCD Panel cycle is closely tied major sports events like the soccer championship. Demand gets hyped up, estimates move up and once the event is in the rear-mirror, demand falls off from the elevated levels & everyone is oh-so-disappointed. After some months the cycle starts anew.

Same thing happening here.

I think GLW is a solid buy here. Goes to $16.25+ on this upgrade. It's not exactly a thin name so don't pay up too much in the pre market. Plenty of room to go long after the open.

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