Since announcing its Strategy and Capital Allocation Framework almost three years ago, Corning (NYSE:GLW) has returned a staggering $10 billion to shareholders, through dividends and buybacks. Earlier this year, Corning authorized a 16% increase in its dividend; since the framework, a plan outlining the company’s 2016-19 leadership priorities, was announced, the dividend has increased a whopping 50%! That’s a lot of money!
While it’s always great for investors to receive a dividend check, some are beginning to wonder if Corning even makes for a profitable investment or, worse, is in financial trouble. For instance, my Foolish colleague Rich Smith recently pointed out that Corning is a company with “no trailing profits to speak of, and extremely limited free cash flow.” The share price has reflected these concerns. While the company enjoyed a great 2017, shares have fallen by about 12% year to date. With this being the case, should investors worry about Corning’s dividend being able to survive? I personally do not believe there is cause for concern. Here’s why.
In recent quarters, Corning has shown both negative earnings and free cash flow. But don’t be deceived; that’s more a sign of accounting smoke and mirrors than the true financial state of the company. Image source: Corning Inc.
Closing the GAAP
For two consecutive quarters, Corning has had disappointing GAAP earnings, yet in neither case did these numbers reflect the true state of the business. In 2017’s fourth quarter, the new tax legislation led the company to report an earnings per share (EPS) loss of $1.66. However, when the new tax legislation was taken into account, core EPS came in at a much better $0.49 profit. Corning reports core revenue and earnings to take into account things such as new tax laws and foreign currency fluctuations.
In the first quarter of 2018, Corning once again reported a GAAP loss but this time the loss could not be blamed on new tax laws. That being said, it was once again more of an accounting fluke than a change in the company’s underlying health. This quarter, currency hedges, which GAAP rules require to be mark-to-market, were to blame as Corning reported another EPS loss of $0.72. Trust me, I barely understand these deep-in-the-weeds accounting rules but, fortunately, CFO Tony Tripeny explained what was going on during his opening remarks in the company’s Q1 conference call, transcribed by S&P Global Market Intelligence:
I want to talk about the primary item effecting [sic] our GAAP results, mark-to-market accounting. As we discussed before, GAAP accounting requires earning translations hedge contracts settling in future periods to be mark-to-market and recorded at current value at the end of each quarter, even though those contracts will not be settled in the current quarter. For us, this resulted in an after-tax GAAP loss of $547 million for the first quarter. To be clear, this mark-to-market accounting has no impact on our cash flow. Our currency hedges protect us economically from foreign exchange rate fluctuations and provide higher certainty for our earnings and cash flow, our ability to invest for growth and our future shareholder distributions … We received $1.6 billion in cash under our hedge contracts over the last 5 years.
Again, Corning’s core EPS showed a much better, though still somewhat disappointing, result of a $0.31 profit.
As for the company’s free cash flow, it has been depressed from the company’s increased capital expenditure. In Q1, like its GAAP EPS, the company’s free cash flow was negative, showing a loss of $335 million. Yet while the increased spending has created a bit of an aura of uncertainty, something the market never likes, it is these investments in its future that I believe will propel Corning to market-beating returns in the years ahead.
Investing for the future
Corning is currently growing at a dizzying pace in order to help meet the demand for its products. Right now, Corning has 23 capital expansion projects under way, including the opening of 11 new plants. Corning’s CEO Wendell Weeks explained in the company’s Q1 conference call that these expenditures, while a drag on gross margins in recent quarters, were necessary to capture opportunities in its markets. After the current quarter, however, management believes these expenses will decrease and margins will rise.
For instance, earlier this year Corning opened a new plant in Hefei, China that enabled it to manufacture a greater grade of LCD glass than anywhere else in the world. This will boost Corning’s display technologies division, which is its most profitable business, generating $185 million in net income in Q1. As Weeks said, “This sets the stage for higher profitability in Display as our new plant and process technology come online in the second half.” While this is just one of Corning’s many new projects coming online, it illustrates how these projects can produce profitable growth. Management states that all its current projects are designed to meet existing customer demand, and should drive efficiency and earnings.
A glass half-full
It can be frustrating for investors to watch a company’s stock price get hit for investing in future growth. A couple of one-time accounting flukes have hit the company’s GAAP numbers to make them appear worse than they are, and heavy investments in Corning’s future have temporarily depressed the company’s cash flow. That being said, if management is to believed — that strong demand is present for the company’s products — holding through these times or even adding to existing positions could be profitable when a proper, long-term mindset is employed.
As for its dividend, I believe Corning will not only survive, but will benefit from more double-digit percentage hikes in the years ahead as the company’s investments today translate into profits tomorrow.