On Monday, October 23, before the opening bell, Corning Inc. (NYSE: GLW) will report its third-quarter results. Will there be nervous anticipation and uncertainty in the wake of Lucent Technologies' (NYSE: LU) reported slowdown in optical networking sales, as well as persistent fears regarding a telecom spending pinch?
Uh, no.
Like the child who opens her gifts the day before the holiday rather than waiting for the big day, Corning late last week unwrapped an upside earnings surprise for shareholders, citing exceptionally strong demand for optical fiber and cable, optical components, and flat-panel glass products. (To read all about the fiber optic boom and the leading companies -- including in-depth looks at Corning, JDS Uniphase (Nasdaq: JDSU), and others -- consider the new Motley Fool Research Internet Report on the topic.)
The company expects to report pro forma earnings of $0.34 to $0.35 per share for the quarter ended September 30, up 75% from last year and $0.04 to $0.05 ahead of the previous consensus estimate. Full-year results are also ahead of schedule, with expectations now around $1.15 to $1.17 per share (versus previous guidance of $1.09 to $1.10), a 70% increase over the prior year. Naturally, fourth-quarter estimates will also need revision to reflect the new full-year target. Earnings forecasts for 2001 have not been adjusted at this time.
For the first six months of 2000, Corning recorded sales of $3.18 billion, with net income of $226 million. Third-quarter revenue is expected to be in the range of $2.7 billion, marking a year-over-year increase of 50%. Gross margins sit at about 40% and net margins near 8%. We can expect improvement in margins when the company reports, due to a more favorable product mix and sturdy fiber pricing.
What to watch at Corning
One item to pay particular attention to on Monday is any sign of improvement in Corning's cash flow efficiency. Cash flow efficiency, as measured by the Foolish Flow Ratio, is a measure of how well a company is managing its working capital, or the proper balance between current assets and current liabilities. Corning's Flow Ratio has been floating up around 2.0 lately, meaning its cash flow is hampered by a glut of noncash current assets in relation to its bills. In the Drip Port's high-growth study, a Flow Ratio of 1.4 or lower is desired.
The Drip Port is also seeking a Cash King Margin of at least 10%. Corning, naturally, isn't living up to this standard right now, as it has negative free cash flow. This is largely due to the company's continuous heavy investments in capacity expansion to support operations growth and to capitalize on the huge demand for optical networking infrastructure. In the first six months of this year, capital expenditures totaled $562.3 million and the company expects the figure to reach $1.6 billion to $1.8 billion for the full year. Investors seeking a dramatic turnaround in free cash flow will need to be patient.
Valuation
Corning is currently trading around 72 times 2001 estimated earnings per share (EPS) of $1.36. The market as a whole, as measured by the S&P 500, is trading at about 23 times expected 2001 EPS. Considering that Corning is expected to grow earnings 27% in 2001 compared to estimated growth of the S&P 500 of 9%, a conservative multiple based on the market average would be about 46 times 2001 EPS. Other than this year, Corning's price-to-trailing earnings ratio (P/E) over the past 10 years has only been above 35 once, and that was last year, topping off around 66. The valuation-minded investor might see Corning riding a little high these days.
However, this isn't the same company it was just a few years ago. Demand for its rapidly growing products -- fiber and fiber cable, flat-panel displays, and photonics -- is stronger than ever. Third-quarter results will reflect photonics sales doubling over 1999 to $250 million, and strong flat-panel display sales growth of 75% year-over-year. Optical fiber led the way in the quarter, and the company expects continued strong growth in that area, along with stable pricing. It's not at all unreasonable to expect premium multiples continuing into the future based on better-than-expected earnings and the bright outlook of optical networking.
On the heels of three straight quarters of upside earnings surprises, on Monday Corning will officially announce its fourth. Since it shed its stagnant housewares division and dove headfirst into optical networking and advanced material products, the company has outgrown its image of a lumbering conglomerate and is moving along at top speed. In other words, Corning is out of the frying pans and into the fiber.
Drip on, Fools!
--Vince Hanks, TMFElwood on the Fool discussion boards
