Tech Suppliers To Consider: 2 "Buys," 1 "Sell"
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you are bullish on the broader tech market, it makes sense to buy industry suppliers. Glass makers are well positioned to ride growing demand for smartphones, yet continue to trade at low multiples despite improving macro conditions. In some cases, however, peers that have grown at higher rates in the past have extended their multiples premium into an environment in which the company is no more likely to outperform. Below, I review several tech suppliers with this thought in mind.
Why Corning (NYSE: GLW) Still Looks Good
Corning is a leading glass manufacturer, and it's story has been highly reflective of the overall industry. It has lost nearly half of its value over the last 5 months while the S&P 500 was almost flat. It looks cheap at current prices, and this is reflected in Oppenheimer's recent upgrade from "perform" to "outperform" and a $16 price target--an estimate backed by National Securities and at a 25%+ premium to the prevailing price. At a 14% discount to book value (well below the 4.4x sector average) and a 12.7% return on invested capital, the upside looks fairly strong. 13 of 18 reporting analysts rate the stock a "buy" or better.
Analysts forecast just 2.6% annual EPS growth over the next 3-5 years. In my view, this is much too low and leads to upside at the current. If Corning could grew EPS by a rate of 8.8% in the last 5 years (during a volatile economic period); it can surely produce a rate half that amount over the next 5 years. There are several reasons to believe the company will succeed in outperforming expectations…
First, management has showcased confidence by boosting its own internal guidance ahead of a conference quarter. Second, LCD demand has come off better-than-expected and is now forecasted for mid-single digit sequential growth. With pricing declines and a 5% sequential gain expected for Specialty Materials off of high double-digit Gorilla Glass growth (60%), investors are likely to start focusing on the upside soon. The launch of Willow Glass for flexible displays will add to this momentum. With a strong balance sheet (as evidenced by the 4.8x current ratio and 34% cash-to-market capitalization), the company is safer than what the market gives it credit for. For this reason, I recommend backing under the expectation that the beta of 1.43 drives up the stock price to at least book value.
TE Connectivity is a peer to Corning and should also be considered. Free cash flow has been consistent despite an uncertain macro environment and still yields 7%. While the stock is more expensive than Corning, it is at a steeper part of its growth curve with a growth rate of 10.1% expected over the next 5 years. Analysts are currently very bullish on the stock and rate it a 1.7 out of 5 where "1" is a "buy."
This will help investors rationalize the discounted multiples relative to Amphenol (NYSE: APH). Amphenol trades at 20.2x and 17.2x past and forward earnings versus 13.7x and 10.4x for TE Connectivity. Much of the premium for the former has to do with the 300 bps-greater growth rate over the past 5 years. However, valuation depends on future growth, and Amphenol's isn't meaningfully better than TE Connectivity's. Assuming Amphenol meets expectations, 2016 EPS will come out to $5.14. At a multiple of 16x, this translates to a future stock value of north of $82. Discounting backwards by 10% yields a present value of around $50. This is at around a 25% discount to the prevailing price and easily warrants avoiding for discounted peers.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Corning. Motley Fool newsletter services recommend Corning. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. TakoverAnalyst does not intend to open a position in the next 48 hours.