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Why Dividend Growth Investors Should Consider Buying Corning

The first few months of each calendar year tend to bring forth plenty of dividend increases from companies in various sizes from different sectors of the economy. So far, 2020 has been no different.

Most dividend growth investors are likely familiar with names such as AT&T (NYSE:T) and Johnson & Johnson (NYSE:JNJ). However, I believe that some of the companies that are not as well known for dividend growth could actually be some of the best dividend growth investments. One of these companies is Corning Inc. (NYSE:GLW).


Background and recent earnings results

Corning is a worldwide maker of glass and fiber optic equipment. The company is probably best known for its Gorilla Glass, which has been used in smart phones for more than a decade. Corning has been in business since the 1850s.

Corning operates through five business divisions: Display Technologies (which produces glass substrates for liquid crystal displays), Optical Communications (which makes fiber and cable hardware), Environmental Technologies (which produces emission-control substrates), Specialty Materials (which manufactures semiconductor optics) and Live Sciences (which produces plastic labware). As of the writing of this article, Corning has a market capitalization of $19.6 billion.

Corning reported its fourth quarter and full year results for 2019 on Jan. 29.

Source: Corning's Fourth Quarter Earnings Presentation, slide 6.

The company earned 46 cents per share in the fourth quarter, beating estimates by 2 cents but declining 22% from the previous year. Revenue declined 7.5% to $2.9 billion, though this was $133 million higher than analysts had expected.

For full-year 2019, earnings were $1.76 per share, which was 2 cents below results for 2018. The company generated sales of $11.5 billion, a 2% increase from the previous year.

Optical Communication, Corning's largest business segment, declined 23% year over year due to lower volumes and reduced production.

Display Technologies was down 12% as higher glass volumes were more than offset by a decline in prices. TV units saw a decline, but average TV screen size improved.

Both Optical Communication and Display Technologies performed much better in the quarter compared to competitors. For example, sales for 2019 were down 3% for Optical Communication, but this market as a whole decreased by a high single-digit rate. Glass volumes for Display Technologies was much higher compared to the rest of the market, and sales for the segment were down just 1% last year.

Impacting results for these two segments was a supply chain interruption and reduced capital expenditures from two major customers. Corning stated on the conference call that supply chain issues have mostly been resolved and new products are expected to go into production this year, which should lead to an increase in demand.

While Corning's two largest segments had down quarters, the remainder of the company showed strong rates of growth in the fourth quarter.

Environmental Technologies was higher by 17% even as the overall auto market struggled. This was due to the company's innovative products like its gasoline particulate filter. This product is expected to see sales double from $250 million in 2019 to $500 million by 2023.

Sales for Specialty Materials improved 14% as the company's industry leading cover glass continues to be in high demand even as unit sales for smartphones were down for the year. As 5G is rolled out, Corning should see demand for cover glass grow.

Life Sciences grew 8% for the quarter. This segment hit $1 billion in annual sales for the first time due to increased demand for products.

Unlike most companies that only give guidance for the current year, Corning laid out its vision for 2020 through 2023.

Source: Corning's Fourth Quarter Earnings Presentation, slide 7.

The company expects sales to grow at a compound annual growth rate of 6% to 8% through 2023, with earnings per share growth of 12% to 15%.

Corning expects most businesses to perform well in 2020, outside of Optical Communications. This segment will likely see declines in the first half, but growth should resume in the second half due to 5G projects and should see growth in sales in the second half of the year.

Along with guidance for sales and earnings, Corning offered its plans for capital returns to shareholders over the next four years. The company aims to return $8 billion to $10 billion through dividends and buybacks to shareholders during this period. This is below the $12.5 billion in capital that the company distributed to shareholders during the 2016 to 2019 period of time, but still a hefty sum given Corning's market capitalization. Part of this return will be $5 billion in share repurchases. This means that the company can buy back more than a quarter of its current market capitalization.

Dividend and aluation analysis

In addition to this stock buyback, Corning expects dividend growth of at least 10% for the next four years. The company increased its dividend 10% for the upcoming March 31 payment. This marks the tenth consecutive year that Corning has increased its dividend. The company has increased its dividend with a CAGR of 10.8% over the last five years.

The new annualized dividend of 88 cents represents just 55% of expected earnings per share of $1.60 for the current year. This is higher than the five-year average payout ratio of 46%, but not at a level that should worry income investors.

Corning's stock now yields 3.3%, which is much higher than the 2.2% yield that shares have averaged over the last decade and the 1.9% average yield for the S&P 500.

Corning paid out $188 million in dividends in the fourth quarter while generating $642 million in free cash flow for a payout ratio of 29%.

Going back further, the free cash flow picture gets slightly less rosy. Due to lower operating cash flow and nearly $2 billion in capital expenditures in 2019, free cash flow totaled just $44 million against $742 million in dividends distributed. Obviously, a company cannot continue to pay a dividend if free cash flow doesn't come close to covering it. However, the payout ratio over a longer period of time is below 100%.

While the long-term payout ratios aren't sustainable, investors should find some solace in Corning's expectations for 2020 as the company sees higher operating cash flows combined with approximately $1.5 billion in capex for the year. This should allow for a more reasonable payout ratio, though investors should monitor this situation going forward.

Using the most recent closing price of $25.72 and earnings per share estimates for 2020, Corning trades with a price-earnings ratio of 16.1. This is below the five-year average price-earnings ratio of 19.2, but above the 10-year price-earnings ratio of 14.9.

Corning's valuation reached single digits during the last recession as earnings declined multiple times in the early part of last decade. Accounting for this, I feel that shares are reasonably valued at 16.1 times expected 2020 earnings.

Investors buying today might not see much in the way of multiple expansion, but a combination of expected earnings per share growth in the low-to-mid-teens and the current dividend yield could offer a solid rate of return over the next few years.

Final thoughts

Investors looking for income should look beyond the most commonly held dividend-paying stocks, as there are other companies that offer a solid yield and dividend growth.

Corning is one such company. Granted, the company saw weakness in two important businesses as last year ended, but these issues are largely expected to be resolved in 2020. Corning believes that just one segment will decline on a year-over-year basis. The company's other segments, which offer products that are seeing robust demand, should all show growth this year.

Shares of Corning are likely properly valued, but the company has guided towards solid sales and earnings growth rates through 2023. The company expects to return as much as $10 billion to shareholders in the form of dividends and buybacks over the next four years. Add in a 3%-plus yield and I feel that dividend growth investors may want to consider buying Corning.

Disclosure: Author is long AT&T and Johnson & Johnson

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This article first appeared on GuruFocus.