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Corning Incorporated Gets Upgraded... but Should You Should Care?

By Rich Smith - Mar 26, 2014 at 4:56PM

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Susquehanna International thinks Corning's a sure thing. But they're wrong.

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our supercomputer tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best...
One week ago, shares of television glassmaker Corning ( GLW 1.05% ) cracked under pressure from a SeekingAlpha columnist, who advocated the merits of GT Advanced Technologies' (NASDAQ: GTAT) "sapphire" glass over Corning's Gorilla glass for smartphones. One week later, shares of Corning are on the rise again (and GT is falling), as a "real" analyst makes the counterargument that, to the contrary, sapphire won't make a dent in Gorilla glass's market share.

The analyst making this argument today is Pa.-based Susquehanna International Group and, as related today on StreetInsider.com, Susquehanna sees a bright future ahead for Corning. Upgrading the shares from neutral to positive, Susquehanna notes that there's "a multi-yr TV replacement cycle" under way right now. Combined with lessened competition as the glass industry consolidates, Susquehanna sees this trend generating expanded profit margins for Corning -- with free cash flow margins potentially reaching 15% to 20%.

According to the analyst, Corning can sell Gorilla glass for about one-tenth the price of an equivalent surface area of sapphire glass. That might not make a huge difference when we're talking only about small-surface areas of glass, such as the camera lens on an iPhone 5S. But once you start talking about larger areas needing to be glass-surfaced -- tablet computer screens, for example, or the ever-expanding faces of smartphones -- that 10x price differential makes sapphire "cost prohibitive," and gives Corning's product a decided advantage.

But is Susquehanna right about this? Is Gorilla glass truly "scratch-resistant" against sapphire?

Let's go to the tape
Ordinarily, to gauge the quality of an analyst's forecasting, our best guide is its record of past success. Unfortunately, Susquehanna's record is a bit of a mixed bag. For example, although we've been tracking this analyst's performance for close to eight years now, we've yet to see Susquehanna make a definitive call on Corning stock even once. (Here... see for yourself.)

On the other hand, Susquehanna does have a pick on record for sapphire glass's biggest fan. The analyst picked Apple ( AAPL 1.39% ) to outperform the market way back in May 2009, has stuck with the stock through thick and thin -- and today, five years later, and after Apple's recent sell-off, Susquehanna is still sitting atop a 228-point win with the stock.

Overall, across 301 stock picks made during the past eight years, Susquehanna has gotten only about 51% of its stock picks right -- yet still managed to outperform the S&P 500 by 18 percentage points per pick, including wins and losses combined.

Success in Susquehanna's future?
Will they do it again with today's Corning pick? It's hard to say.

Priced at 15.4 times earnings, growing earnings at 13%, and paying a 2% dividend yield, Corning shares look fairly priced today -- not cheap, but not overly expensive either. Corning's balance sheet shows $1.9 billion more cash than debt (a good thing), but its cash flow statement confirms the company is still generating about 10% less free cash flow than it claims to be "earning" under GAAP (a bad thing).

On balance, I'd say the risk and reward are pretty equally weighted on this stock -- for now. What worries me, and in the end makes me inclined to ignore Susquehanna's buy recommendation on Corning, is the analyst's suggestion that Corning can count on a "free cash flow margin" of only 15% to 20% going forward.

Right now, the $1.8 billion in free cash flow that Corning generates from its $7.8 billion in revenues works out to a FCF margin of better than 22%. A decline to a 20% -- or even 15% -- FCF margin, though, would significantly erode the company's cash profits and, in my view at least, make Corning a much worse bargain.

Given Susquehanna's iffy, near 50-50 record of being right on its stock picks, that's not a risk I'm willing to take.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
AAPL
$167.59 (1.39%) $2.29
Corning Incorporated Stock Quote
Corning Incorporated
GLW
$37.48 (1.05%) $0.39

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