TE Connectivity: Attractive, Safer Alternative To Corning

By David Gould - September 4, 2012 | Tickers: GLW, TEL | 0 Comments

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While the S&P 500 has gained by 19.8% over the last 12 months, Corning (NYSE: GLW) has fallen by nearly an equal amount. Although the dividend yield has helped to mitigate some of the downfall, visibility is extremely limited and will limit the ability of management to recover lost value. At this point, however, shares are appearing low at around 8.4x past and forward earnings. The firm is also 16% below book value and is forecasted for just nearly half of the annual earnings growth (4.6%) during the past 5 years for the next 5 years. This sets the bar low for higher risk-adjusted returns. In my view, however, the lack of visibility warrants holding only a small speculative position.

Corning currently has a net cash position north of $3B, which represents 17.3% of market capitalization. On August 31, 2012, Oppenheimer released an "outperform" rating on the stock with a price target of $16. This followed a "buy" rating with a $15 price target by Stifel Nicolaus around one week earlier.

As undervalued as Corning may seem, it still is not significantly below the historical 5-year average PE multiple of 10x. While profit margins have largely gone up, free cash flow trends have been more than shaky. FCF for the TTM ending 2Q12 was $1.1B versus $1.9B in 2Q11 and $2.1B in 2Q10.

Going forward, Corning's major catalysts will come from moderating display glass prices to better align with demand. Not nearly as risky as the bears would have you believe, price declines for LCD glass were considerably more moderate in 2Q. Moreover, economies of scale have led the company to maintain its outlook for the 2012 retail glass market size despite an uncertain environment.

Economic headwinds are starting to become particularly pronounced. The result has been lower sales in light-duty Environmental products (largely in Europe), and this trend may carry into heavy-duty diesel soon. R&D spending was flat in 2Q while SG&A rose. Overall, prices fell moderately while volume in SCP rose in the mid-single-digit sequentially. Poor innovation, coupled with weakening bargaining power, will limit the company's ability to exploit prosperous economic times when "higher value" brands are sought.

One attractive alternative to Corning with more favorable risk/reward is TE Connectivity (NYSE: TEL). The stock trades reasonably at 13.9x past earnings and free cash flow has been consistently growing from $1B in 2Q09 to $1.3B in 2Q12. TE Connectivity is rated a 2.7 out of 5 on the Street where "1" is a "buy".

Analysts forecast 9.2% annual EPS growth over the next 5 years, which, at a 13x multiple, translates to a future stock value of $50.44. Discounting backwards by 8% (since these projections are very reasonable) yields a present value that is roughly in-line with the current market assessment. Thus, while TE Connectivity does not have a strong margin of safety, it nevertheless has large enough upside to warrant an investment.

In fact, the firm has roughly double the volatility of the broader market. This is likely to cue outperformance when the market negativity dissipates. Profit margins have picked up into the north of 10% area. Sales grew 8% sequentially in 3Q to $3.5B and, while being slightly below expectations due to FX headwinds, were compensated by an adjusted operating margin improvement of 100 bps. As TE Connectivity improves its cost structure, it will become increasingly suited to exploiting opportunities in a full recovery. I thus recommend buying shares in tandem with a lighter and riskier position in Corning.

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