Corning (GLW) reported 4Q results of $3.41b, down 2.4% q/q and down 7.3% y/y and below consensus of $3.55b.  EPS was a reported $-0.04 but core results of $3.63b and $0.47 saw sales slightly ahead of consensus and toward the high end of previous guidance, while core EPS was $0.02 above consensus.   The company took a $150m restructuring/impairment charge in the quarter, primarily related to inventory.  Corning was able to institute price increases in both optical and life sciences, which, along with inventory reductions and “productivity improvements”, which seem to be rationalizing capacity to lower levels more in keeping with current demand, helped profitability and should help to increase margins in subsequent quarters this year.  That said, guidance was for $3.2b to $3.4b, below consensus of $3.58b and (core) $0.35 to $0.42, also below consensus of $0.46.
 
Key Points:
 
Weak Sales Guidance - Corning expects sales to decline between 6% and 11% against a company norm of -5% as a number of business segments see slower than expected demand.  While it is hard to call the return to pre-pandemic demand levels for most CE products a surprise, the rapid change in COVID restriction attitude in China was unexpected, with that event another rain cloud in what Corning was predicting would be a more sunny 1Q and we fault few managements for not anticipating such a radical change in philosophy.  That said, the direction in the display space was obvious by 3Q last year, and while the mantra of serving the customer at all cost was necessary in 2020 and 2021, most managements were slow to respond to what was an overheated CE environment last year.  Corning seemed to be half in and half out as to its expectations for direction in 3Q and 4Q last year, but now seems to have accepted a return to pre-pandemic levels and the uncertainty of China’s recent COVID ‘transition’.  That said, it is easy to be fooled by seasonality and we hope that the company is careful about responding to short-term changes in demand, especially if they are related to building seasonal inventory, as we expect consumers will be a bit more careful about how they spend on CE products this year.
 
Display recovery delayed – Management sees a recovery in the display space now pushed out by at least one quarter.  During the 3rd quarter call, management indicated it felt that the display industry had reached a low point toward fab utilization, and while they were cautious about calling for a quick recovery, their expectation seemed to be toward improving demand and higher utilization rates.  Both October and November did see utilization improvement, but China’s abrupt about-face toward COVID lockdowns, and the resulting rapid spread in December, pushed utilization back to previous low levels.  January has seen little change, which pushes out Corning’s expectations for a display recovery by 1 quarter.  More to the point however is what kind of recovery might be seen as the year progresses, and we expect more of a grinding recovery than a steep one, with only a few industry events or new products to push the space into the consumer spotlight..
 
Incremental improvement each quarter – Management expects sales improvement in 2Q and the 2nd half, although they were less clear about the momentum of such a recovery.  Citing the concept that they were primarily interested in serving their customers during the pandemic, inflation and supply chain issues caused less of a focus on productivity and profitability.   Corning’s focus has changed, and after both price increases and capacity rationalization, the necessity to ‘feed the beast’ is a bit less important than remaining profitable and able to return capital to investors.  While there is a bit more stability in raw material prices, albeit still at higher than pre-pandemic levels, we applaud that return back to maintaining a higher level of profitability by matching current capacity and costs to current demand.  It’s a harder balance to maintain, but given the uncertainty ahead, it is an absolute mandate.
 
While Corning has taken steps to realign itself with the current demand picture, even as we finish January, they were still unclear as to how the quarter would play out, and the cautious guidance reflects that.  The company admitted that it had been surprised by rapidly changing events during 2022 more than once and was certainly less certain about the momentum behind a recovery in a number of their business segments.  With display and specialty materials reaching just south of 50% of total company sales in 2Q 2020, their combined share of company sales has declined to 37.8% (4 year low of 34.5% reached in 3Q), and a return to those heady days seems a difficult case to make, and therefore less dependency on product and glass volume growth from these segments puts considerable pressure on Optical to carry that weight, making Corning more sensitive to the optical space than either display or specialty materials.  While the company hinted as to new products for AR/VR and its close ties to foldable display production, we expect glass volume growth will be modest this year, although we expect pricing will remain stable.
 
We do expect at least some seasonality in the display and specialty materials segments throughout the year, although from a sales perspective 1H comparisons will be difficult, but more will depend on the company’s ability to bring margins up in both segments as optical remains a wild card early this year.  Hopefully a more realistic outlook will hold display and specialty materials inventory and capacity to more reasonable levels, as we expect any bounce back in demand will be a bit more gradual this year, giving a bit more time to relight glass capacity when needed.  While there is no escape from the weakness in the CE space for Corning, at least they have enough business balance to continue to generate positive cash flow and maintain a solid balance sheet, which is more than we can say about many others in the CE space.
 

​Speaking at a conference yesterday Corning (GLW) management indicated that while all other segments are operating in line with 3Q guidance, the display business is not and is expected to come in at or below the previous guidance.  In order to put that in perspective, here are some notes on 2Q Display segment performance and 3Q guidance:
2Q Display Performance

• Display Sales $878m – Down 8.4% q/q – Down 6.5% y/y
• Display Segment represents 24.3% of reported sales & 23.3% of core sales
• Display Net Income $228m Down 3.4% q/q – Down 8.1% y/y
• Glass Pricing – Up slightly

 
3Q Display Guidance
 

• Overall company sales (full year) slightly above $15b which implies (reported) sales of ~$7.715b in 2H, up 5.7% h/h or up 3.7% h/h on core sales.
• Expect 3Q sales flat q/q and up y/y, implies $3.65 to $3.85b
• Expect Glass volume to be down ~15% q/q across industry & company
• Expect flat glass pricing q/q
• Expect TV units to be flat to down y/y

 
3Q Updated Display Guidance
 

• Lower than anticipated glass volume brings overall guidance 3Q guidance to low-end ($3.65b) or below original range, taking at least $100m (single point) from full year unless 4Q is stronger than expected overall.
• 3Q will be the low in quarterly display glass demand
• TV units still flat to down
• Too early for 2023 TV shipment estimate but likely to return to ‘normal’ range of 225m to 235m

 
A 15% volume reduction (already anticipated) would result in 3Q display sales of $746m.  As it seems glass volumes have deteriorated further and pricing expected to be flat, that would imply display sales ~$700m, down roughly 26% y/y for 3Q (down 20% q/q) or about $50m lower than guidance which leaves us with the possibility that either a 20% reduction in glass volume is not enough or there are other segments that are weaker than expected.  We would assume the former, although it could be a bit of both given the macro environment.  Corning indicated that the incremental display glass volume shortfall was a result of the COVID lockdowns in China, despite the insistence of affected Chinese panel producers that there would be little effect on production, with Corning being a far more credible source.
 
Corning did say that on a long term basis they believe the prospects for the display business remain ‘good’ and acknowledged that the pandemic caused ‘advanced purchases’ to be made in the TV space which pushed TV units above the normal range, but while not giving an estimate for 2023 they indicated that TV units in 2023 would likely be back to that ‘normal’ range.  If one looks at the display industry from a capacity perspective, production capacity for fabs above Gen 6, which would be used primarily for TV panel production, make up ~73.2% of overall LCD capacity (100% yield), so the TV space is of great importance to Corning, especially in China where Chinese display glass producers supply primarily Gen 6 and smaller glass substrates and Corning is the share leader in large size substrates.
 
One point that is critical to the glass substrate market is glass prices, which have been stable to positive for the last few years as glass demand has either outstripped or been equal to supply.  While overall available capacity has not changed significantly, given the high cost and technical knowhow needed for new entrants, with the very weak demand seen this quarter, low panel producer utilization rates, and panel prices at or below cash costs, panel producers will be under pressure to reduce costs further.  While they are always looking to bring down material costs, glass is so essential to making LCD panels that sustainable availability has taken preference over price, leading to stable or rising glass prices.  Corning believes that glass substrate pricing has only a small effect on the overall profitability of the TV industry and that rational behavior by the small number of substrate glass competitors, meaning balancing production capacity against demand, is responsible for the stable glass pricing seen in recent years, but we are always concerned that a sustained period of weak panel production, and/or weak consumer demand will push panel producers to negotiate pricing with a bit more emphasis on absolute price. 
 
With the weaker demand seen currently, display glass producers are taking tanks off-line to do maintenance tasks that have been postponed over the last few quarters or years in order to meet demand.  While fewer tanks will keep capacity tight, once relining or other tasks are completed, a decision as to restarting the furnace must be made, with the cost of maintaining a non-producing furnace line a major consideration.  If display demand returns, all will be right in the glass substrate world, but sustained weak demand could put pressure on glass producers to restart idle tanks and to fill those tanks some price concessions could be offered.  We are always concerned about material costs in the display space, but since 2020 the industry has seen what we call ‘artificial’ demand change some of the rules.  Without that demand, do we return to the old normal where glass prices decline a bit each quarter or has the glass substrate industry learned that profitability is more important than share, a lesson not everyone in the display space pays attention to.  If the next two or three quarters do not show signs of improving demand, we would expect glass prices to flatten or go negative later next year.  We give that scenario relatively low odds but given the recent environment they have to be considered.

​Corning (GLW) reported sales of $3.615B down 1.8% q/q but up 3.3% y/y and core sales of $3.762b up 2.2% q/q and up 7.4% y/y but slightly below consensus of $3.78b, while EPS was $0.57 against expectations of $0.56.  Broadly the display segment was weak, along with automotive and specialty materials, although specialty materials performed better than the weak smartphone market it serves.  Optical was strong and is expected to continue to be so and display, which was affected by the utilization cuts in June, is expected to continue to be weak through the 3rd quarter.  Corning continues to see the uncertainty coming from Chinese COVID-19 lockdowns as a key point toward how the full year will play out, with all three weak segments being held captive to the region’s policies.
Given our focus on CE, we note that display sales were down 8.4% q/q and down 6.5% y/y as utilization rates were cut by panel makers in June to give the industry time to absorb excess inventory and (hopefully) stem large panel price declines.  Glass pricing was up slightly in 2Q but Corning expects display glass pricing to remain flat in 3Q despite the lower volumes as a seemingly rational approach by the major display glass producers to take capacity off line is the basis for those expectations.  We do note that until recently display glass producers have been running capacity near full utilization and tank cleaning, repair, and modernization has been postponed.  Now that demand has slowed such work can be done as warranted, but the question of whether that capacity will be returned to production or held in reserve is still an unknown.
We expect the three major display glass producers, Corning, AGC (5201.JP) and NEG (5214.JP) to maintain reduced capacity through 3Q and likely into 4Q, but our concern is more from Chinese glass producers who have yet to prove themselves as other than price competitors.  Given the opportunity to capture share, particularly on the Mainland, price is their leverage as they are subsidized by the government.  As the year will likely generate losses for Chinese glass producers, share gains would serve to bolster their standing with the local and provincial governments so there is a chance that pricing pressure could be seen before the end of the year however we believe that the more rational behavior of the majors will be able to maintain relatively stable glass pricing through the end of this year, with early 2023 being a more opaque pricing environment.
With optical growth offsetting the weakness in display and the specialty materials end market (smartphones), we would expect to focus more on how carrier build-outs are being affected by the current inflationary environment in 3Q and 4Q to gauge how long optical growth will be able to offset display weakness.  While TV set shipments typically improve in 2H, we expect this year will see a weaker 2H than 1H unless prices deteriorate so quickly that consumers feel obligated to take advantage of such discounted pricing.  However, as we have previously noted, there is still high-cost TV panel, component and set inventory to be worked down before the impact of lower panel prices can be felt at the consumer level and while we have seen some component and raw material price declines, they will take some time to work through the supply chain.  Price elasticity remains but the effect of inflation on consumer buying power coupled with IT demand pull-ins earlier this year make for a teeter-totter situation that shows no clear cut direction yet and Corning’s full year grow is quite dependent on the balance between its product categories.  A shift in one direction or another could be the swing factor between the 6% to 8% predicted for the year or adjusted guidance in 3Q.  

​Given the relatively small number of major display panel producers that supply the CE market, it seems surprising that the number of display glass suppliers that feed such businesses is even smaller, however the cost of building and maintaining the facilities needed to produce this high quality specialized glass is extremely high and limits those who have the financial strength to build and sustain those facilities, and to compete financially in that market.  Dominant players, such as Corning (GLW), AGC (5201.JP), and NEG (5214.JP) have built relationships with display producers, with some glass production lines built alongside display production fabs to facilitate the rapid transport of such large and fragile glass substrates without the need for the extensive packaging needed for long-distance shipments.  As the largest substrate (Gen 11) can run to over 11.5 m2 (118.6 ft2 or eight 65” TV panels) and can be less than a millimeter thick, they are extremely difficult to move and even more difficult to transport to other locations.
Given that the production of LCD TVs is based on glass substrates and that a relatively small (15,000 sheet/month) Gen 8 fab line can produce up to 120,000 65” TVs/month, there is a very significant need for fabs to have both substrate inventory and short-term access to supply as a shortage of glass mass production stops, which not only leads to missed display delivery deadlines but can require equipment resets and recalibration of tools remain idle for an extended period, adding to delays.  Therefore it is incumbent on panel producers to maintain strong relationships with the few glass producers that are able to produce the quality and quantity needed, with those relationships being based on contracts that can specify area, unit volume, or percentage of production requirements, which can create an imbalance in glass supply for smaller panel producers.
In addition to the above, the dominance of Chinese LCD panel producers has intensified the desire of the Chinese government to extricate itself as much as possible from the display supply chain, with a long-term focus on display glass given it underlying importance to the industry.  Over the years the Chinese government, along with provincial and city governments have financed and subsidized an number of projects to build a display glass infrastructure on the Mainland, however it has proven more difficult than expected, both from a technological and from a financial perspective.  Chinese display glass substrate companies have made headway over the years and supply smaller glass sizes to a number of Chinese LCD display fabs, but have note been able to reach the quality and quantity levels needed for larger panel sizes where margins are higher and demand is still growing.
Companies like IRICO (600707.CH) and Dongxu Optroelectronics (000413.CH) have either been funded by the government or partnered with foreign glass producers to develop their own more advanced display glass production facilities in China to less the country’s dependence on foreign glass imports, but not all of those projects have turned out to be as easy as expected, even when paired with Chinese panel producers.  Recently Dongxu Optoelectronics gave guidance of another loss for the 1st six months of this year, and while the loss range was slightly less than last year’s 6 month loss, the company has yet to show a profit after years in the business, indicating that even with tax incentives and operating subsidies, the profitable production of display glass requires much production experience and process knowhow.  Dongxu stated that the reason for the loss was the company’s investment in R&D for the development of display materials, production line costs, and the amortization of intangible and fixed assets during the early stage of expansion, but it also includes interest payments on bank loans and lower sales as the display business contracts.
Further, the company tried to diversify a few years back, expanding into LED based products and glass related automotive products and we believe is one of the automotive glass suppliers to LG Display (LPL), but the company side businesses generated even larger company losses and helped to produce quarterly losses for the company for the last three years.  In 2020 the company refocused on developing a glass product line for OLED displays and lessened its focus on non-glass products but this has done little to stem the losses. In fact Dongxu failed to repay principal and interest on bonds it issued in 2016, which amounts to a bit over $605m in the aggregate and while the company, as part of its expansion, created its own finance company, the company it limited in what it can withdraw from the financing unit.  Dongxu itself has a capital book balance of 9.4b yuan ($1.39b US) but 91.5% of that capital are restricted funds and the book balance of interest bearing liabilities is 24.87b yuan ($3.681b US) of which 8.1b yuan (~$1.2b US) remains unpaid, making it difficult to see how the company can extricate itself from its financial issues.
While the company’s parent Tunghsu Group (pvt) has agreed to buy ‘up to 1.5b yuan worth of shares within six months and the company is working toward extending its debt maturities despite the plan’s initial rejection by shareholders, this all goes to point that throwing money at an industry does not always guarantee dominance or even success, especially in an industry where some of the participants have been suppliers since the industry began  We expect Dongxu to survive in some form given the potential support of Tunghsu Group and potentially the local government given that the company has over 4,000 employees, but the desire for a localized supply chain in a global market is not always the answer to the natural or political conflicts that occur in the course of doing business on an international basis, and while China has been successful in a number of instances in the CE space, nothing is guaranteed.

​AGC (5201.JP), aka Asahi Glass, a competitor to Corning (GLW) and NEG (5214.JP), has raised their 1H sales and operating profit guidance.  Sales, which were original forecasted to be ¥870b yen, have moved up by 11.5% to ¥970b and raised its 1H operating profit forecast by 21%.  The new sales forecast is 7.2% above last year’s 1H, while the new Op Profit forecast is up 20.8% over the same period last year.  The original forecast was made by the company on 2/8/22.  While we were hoping that the increase might have been associated with the company’s display glass business, Asahi indicated that the company’s caustic soda (Sodium Hydroxide – NaOH – aka lye) business was positively affected by price increases in the chemical, which is used in paper processing, soap manufacturing, and in the refining of aluminum, along with a number of food preparation processes.   The company also indicated that its PVC (polyvinyl chloride) business, among the top 3 synthetic polymer plastics produced globally, saw higher than expected prices in Southeast Asia during the 1st half.  The company was also able to pass on the higher cost of raw materials and fuel prices to customers in its architectural glass business in Europe.  No mention of the display glass business.  We will likely have to wait until the call next month.

There are those that walk around and use smartphones that have cracked screens.  While Corning’s (GLW) Gorilla Glass™ and Asahi’s (5201.JP) Dragontrail™ and their predecessors have gone a long way to keep smartphone screens intact, along with the hundreds of protective cases available for almost any smartphone brand, there are times when phones fall on bathroom floors or concrete train platforms with the result a cracked screen.  Getting a screen fixed if you do not have a repair plan attached to your phone can be an expensive and time consuming task that leaves you without a phone for some indeterminate period.
For a short time, if you happen to have a particular Samsung (005930.KS) smartphone, you can get your phone’s screen repaired for the bargain basement price of only $50, and this is a bargain for anyone who needs a screen repair when compared to the cost of replacing a damaged screen at other times.  Looking at Samsung’s entire line of smartphones, the top of the line Galaxy Z Fold 3 ($1,799), the cost of an inner screen replacement for that phone is $479, which is 26.6% of the initial price of the phone and for a screen replacement for any of the three fold models (Fold, Z Fold 2, Z Fold 3), the average cost to repair the inner screen is 28.1$ of the initial cost of the phone and the cost for the lower priced Galaxy Flip line runs to 35.6% of the initial price of the phone..
Of course, foldable screens are going to be more expensive than most, so we take it a bit further and calculate the cost of replacing the rest of the Samsung Galaxy line  back a few years to see the cost for other more ‘normal’ display replacements.  The average cost to replace a screen on a Galaxy S series (Flagship) smartphone runs between 19.9% and 30.4%, while the cost for the now defunct Note line ranged between 20.7% and 25.7% of the initial cost, but what turns out to be the most expensive replacements are those for Samsung’s mid-to-low tier line, the A series, where the cost of replacing screens for these budget phones ran from 25.9% to 61.2% of the initial price.
There are some rules during the promotion however:

• You must be a resident of the US (50 sates & DC)
• You must mail-in your phone (No walk-ins)
• Does not apply to frame or back glass
• No Samsung partners are participating (including Best Buy (BBY))
• You have to open a Samsung account
• The promotion runs from 6/13 to 6/27
• Eligible phones –
  • Any Galaxy S phone from the S9 and new series except the S21 FE & S20 FE
  • Any Galaxy Note 9 or newer phone
  • Any Galaxy A phone (No ‘J’ series phones)

We have not seem many of these promotions so if you have a cracked screen on any of the above Samsung smartphones you should take advantage of the offer.  Perhaps Samsung is trying to reduce replacement screen inventory, but whatever the reason such offers should be taken when they are present and this one will only last another two weeks.  Unfortunately you will be without your phone for some period of time (no timeframe given) but burner phones at Walmart (WMT) are as low as $20.00 and you can always justify a back-up phone for those times when yours slips under the couch cushions for a few days.

​Corning (GLW) reported a strong first quarter with GAAP sales of $3.68b, above consensus of $3.55b, and non-GAAP EPS of $0.54, also above consensus of $0.49.  The company guided to a range of $3.7b to $3.9b (consensus $3.69b) for 2Q, with core EPS between $0.54 and $0.59 (consensus $0.55) for 2Q.  Full year guidance was given at >$15b (consensus $15.04b), with core EPS growing at high single digits and core EPS a bit faster than sales.  On a general basis, the quarter’s strength came from price increases the company instituted to cover increased raw material and logistics costs and continued strength in the optical communications segment, as demand from carriers for 5G and HPC continued.
Our focus tends to be on the display side of Corning’s businesses, which includes traditional display glass and specialty materials (Gorilla Glass, etc.).  The display glass segment posted sales of $959m, up 1.8% q/q and up 11.1% y/y, with net income of $236m, down 6.3% q/q but up 10.8% y/y..  Display segment net margins were 24.6%, a bit lower than we expected but not out of line with typical years.  Glass prices rose slightly in the quarter, and as we have noted in the past, this is an unusual occurrence, as glass prices typically tend to decline.  The display glass market is one with few suppliers and high barriers to entry, which has allowed Corning and other producers to maintain stable glass pricing over the last few years.  With glass demand driven by average panel size increases and increased panel capacity, the environment for display glass has been ideal.
Corning has ‘share’ agreements with most of its customers, which gives them access to a percentage of Corning’s output for the quarter or year, but pricing is adjusted on a quarterly basis.  It has been difficult for Corning to renegotiate pricing most recently, not because of customer resistance to higher glass prices, but more to be able to renegotiate fast enough to cover the increased costs of raw materials and transportation.  We would expect to see at least another quarter or two of display glass price increases as Corning catches up to increased costs, especially in transport as Corning’s inventory levels have been low, pushing them to use more expensive air transport to meet demand deadlines.  With expectations of low display fab utilization, Corning will continue to run glass production at levels that allow it to build inventory, which will help to maintain margins, especially in light of continued glass price stability or increases, but display glass sales need both increasing volumes and average panel size increases to maintain growth.  We expect that weakening demand for TV and notebook demand will begin to make y/y cmparisons a bit more difficult in 2H, and while that does not change our broader view of the display glass segment, it does temper our enthusiasm a bit, even after a strong quarter.
All in, Corning performed quite well in the quarter and will likely do so again in 2Q, and strength in the optical segment will likely offset even a small amount of weakness in the display space.  Specialty materials, which saw sales increase 9.3% y/y saw net income decline by 17.6% as the segment invested in new product development, which has been the driver for the segment for the last few years.  Smartphone demand remains somewhat stagnant, but Corning continues to develop products that lead to higher content/device, which is the ultimate driver for the segment and automotive Gorilla Glass and similar products are finally coming to fruition.  While there are certainly product areas where there are risks for Corning, it seems to be the definitive defensive play when large cap hardware technology companies are under pressure.

Are waveguides applications for finding the ‘perfect wave’ at beaches across the globe, or are they those plastic things at the ends of sci-fi weaponry that help aliens shoot straight? No, they are neither of those but are a key component for XR products, especially AR devices.  While most folks are focused on the metrics of the display used in XR products, in AR the user must be able to clearly see what is in front of him, while in VR the display is the visual objective.  In order to get an image to AR glasses, the display image has to be combined with the actual visual image seen by the user, and that is done by optically combining the two sources.  The waveguide operates a bit light the optical fiber that brings entertainment to your home.  The display that carries the ‘overlay’ image into the waveguide which then reflects the image from side to side through the waveguide while moving it forward until it reaches the users eye.  While the waveguide is nearly 100% reflective on the interior, it is also transparent allowing the user to see both images at the same time.
In order to get the image to move through the waveguide it must be injected at an angle and the refractive index of the waveguide material must be high or the field of view will be relatively small, meaning you would be limited to a narrow left/right and up/down view.  That is where specialty glass producers such as Corning (GLW), who happens to be an investor in waveguide producer DigiLens (pvt) come in, creating such highly refractive glass that make waveguides viable.  There are a number of ways in which waveguides can be applied to AR products and other optical techniques can be used to create an AR system, such as mirrors and prisms, but waveguides are a hot topic in the AR world and  are considered one of the leading technologies for AR going forward, especially because they allow the display projection system to be small and less bulky that most optical combiners.
The problem with waveguides is they are more difficult to produce that typical display glass and must have uniformity and surface roughness metrics that are an order of magnitude better than those of display glass.  They are produced on wafers, which increases the cost of production but also allows for patterns to be etched in the glass that help to gather more light, and as such processes are more similar to semiconductor manufacturing, there is considerable room for advances to be made in production techniques.
DigiLens produces such waveguides and has just raised an additional $50m, bringing its capital from investors to $160m in 7 rounds.  Some of the investors in those rounds are Samsung Electronics (005930.KS), Universal Display (OLED), Dolby (DLB), and Corning, along with a number of US and foreign VCs, and will help push the company’s more specialized waveguide technology into volume production over the next year.  Given that their manufacturing process is scalable and cost effective while having better FOV and overall characteristics than competitive offerings, the company feels that they can dominate the waveguide space going forward.  We note that while there are other optical systems available to AR designers, waveguides are the most common in our AR database, especially among those AR devices that have been announced but not yet released.

​As we have mentioned in the past, much is made in the Chinese trade press about the country’s ability to dominate the LCD display business over the last few years, and credit where credit is due, as Chinese display producers such as BOE (200725.CH), Chinastar (pvt), and HKC (0248.HK) have become dominant or major players in the LCD space, particularly in reference to large panel LCD display production.  Much of this comes from the addition of new LCD capacity at the Gen 8.5 or Gen 10+ substrate sizes, with particular emphasis on Gen 10+ fabs. 
One area that has been neglected by the Chinese display industry is glass substrates where much of the industry relies on a small number of display glass producers that are both well established and have a vast production knowledge-base.  While China does have a few display quality glass substrate production lines there is only one that is able to produce substrate glass for Gen 8.5 panel production and none that are able to produce substrates for Gen 10+ fabs, most of which are on the Mainland.  This leaves Chinese large panel producers to depend on Corning (GLW), Asahi (5201.JP), and NEG (5214.JP) for those substrate sizes, with some producers building glass production facilities for Gen 8.5 and Gen 10 on the production campuses of those fabs.
We have seen statistics as to how China is developing it substrate glass industry, soon to ‘dominate’ as the country has done with panel production, but in reality that bravado is a bit misconceived.  We see Gen 10+ panel production capacity growing 31.5% this year, representing 21.8% of total industry capacity, which is up from 14.8% of the industry total last year, with growth below Gen 8.5 non-existent in the LCD space.  As larger glass sizes tend to come at a premium, not only does Gen 8.5/Gen10+ glass represent the only capacity growth in the LCD space, but maintains higher margins than generic substrate glass sizes. 
Much of this is the result of the technology used to produce substrate glass, which requires considerable production and formulation expertise that is not easily generated during the production of other glass types, and as Chinese OLED panel producers have learned, that technology expertise takes considerable time and expense to learn.  All in, if Chinese glass ‘domination’ were near, we would expect Mainland producers to be in production at Gen 10+ sites across China, which it seems they are not and given the unusual stability of substrate glass prices over the last few years, competition is little changed.

As has been the case in the past, we look at Corning (GLW) differently than most as our focus is on two rather than all of the company’s product segments, display and specialty materials, which represented 39.3% of core sales in the 4th quarter and 40.4% of core sales for the full 2021 year.  However on a net income basis these two divisions represented 70.6% of 4Q net income and 73.5% of same for the full year, and while they might not be the drivers for growth in every quarter, they are essential for Corning’s sustained profitability.
The display segment, which supplies substrate glass for LCD and rigid OLED display production, saw a 1.5% decline in sales on a q/q basis but was up 12.0% y/y.  Typically 4Q display sales are up 1.8% q/q, but given the new world we live in currently, we chalk up the difference to the variety of factors that are now part of the CE supply chain.  Display net income in 4Q was up 2.0% q/q and up 16.1% y/y with 4Q display margins at 26.8%, the highest they have been this year and since 1Q 2017, as very favorable glass pricing continues.  We note that the display glass business is one with few suppliers and high entry cost, but one that typically has seen gradual glass price declines built into panel producer supply contracts, although that has not been the case since late 2020 when it became more important for producers, especially those in China, to secure steady supply than to haggle over small price reductions.  This has allowed Corning and other glass suppliers to maintain glass prices and even see some increases, helping display segment margins increase from a low of 22.6% in late 2017 to where they are today. 
There is some nuance to Corning’s glass substrate business however that does give them an edge over other suppliers and that is their expertise in large substrate production, which has made Corning the leader in that market segment for the last few years, particularly as Gen 10.5 fabs became popular, and while Corning’s large panel glass supply relationship with Samsung Display (pvt) has slowed as SDC moves away from large panel LCD production, it has increased with Chinese panel producers who have become primary suppliers of large panel LCD displays.  Given that average TV sizes have been increasing for the last few years, the necessity to produce such large panels in Gen 10.5 fabs has helped Corning to maintain its leadership position in such large panel sizes, cementing their relationships with such fabs by co-locating glass production facilities at the fab itself.
There are mitigating factors however that also fall into the glass business and that is new capacity and utilization rates, with new LCD capacity being the long-term growth driver and utilization being the shorter-term driver.  Until the middle of 2021 large panel LCD display industry had been seeing strong demand and increasing TV panel prices as a result of COVID-19, contributing to the performance of Corning’s display segment.  That, coupled with LCD capacity growth incentivized by Chinese government subsidies has created the optimal environment for glass suppliers.  However things changed a bit in 2H 2021 when the increased cost of TV panels and other components began to impinge TV set sales while overall TV demand slowed as governments began to remove some of the COVID-19 mandates that had fueled demand in early 2021.  TV panel prices fell and panel producers moved production to IT products that still saw stable pricing.
The effect of such a change, while seemingly a watershed event, was relatively minor for the glass industry as demand for IT products remained strong and therefore overall utilization rates remained high, but as the industry entered 4Q, it became necessary for panel producers to lower TV panel production utilization or face even greater TV panel price declines, which was the first of two events that will set the tone for display in 2022.  The second was the beginning of price declines for IT products, again we believe prompted by the mindset that the COVID-19 pandemic was at least under some level of control and the shelter-at-home necessity was lessened, as we noted yesterday.  This is important in the sense that the shift by panel producers toward IT production increases their sensitivity to IT panel price declines, and leaves them little recourse but to lower IT panel utilization if demand for IT products returns to pre-COVID levels, with lower utilization meaning less glass demand.
It will be difficult to discern how much ‘normality’ will be seen in 1Q display results, for Corning and for other component suppliers as 1Q is typically the weakest in terms of CE demand, but while Corning was optimistic about the prospects for the display space and the glass market this year, and guided to flat glass pricing and a continuing tight market in 1Q ’22, we expect much of that optimism is based on contract negotiations that occurred in late 2021, with panel producers a bit more optimistic than they might be now.  That said, glass prices don’t change quickly and with high fixed costs the competition has little room to undercut Corning’s dominant position with price, unless they are willing to create a deficit, so we see the second quarter being the key for the display space, as a sustained demand downturn would begin to affect overall material demand, or a more stabilized demand environment would lead to a continuation of Corning’s strong display segment margins.  We hate to say 1Q is a throw-away quarter, but its seasonality make it one that can hide a multitude of sins.
The specialty materials segment, which is primarily a supplier of cover glass to the display industry, along with some specialty optical products, saw a 6.8% q/q decline in sales, also a bit more than the 5 year average of -4.2% q/q, but was down 5.0% on a y/y basis.  As Corning sells cover glass to processor, rather than directly as it does with substrate glass, they have a less direct ‘demand connection’ which can move segment results away from expectations, in both directions, but 4Q is a volatile quarter for specialty materials with q/q spread between +5.4% and -13.1%.  That said, net income from the specialty materials division was down 14.0% q/q and 32.4% y/y, with the only y/y growth seen in 1Q against a very weak 1Q in 2020. 
No direct 1Q guidance was given for Specialty Materials with a broader ‘expect sales to grow faster than our underlying markets’, but Corning added that the lower net income was the result of investments in new innovations that will be commercialized this year with a nod toward optical products for EUV lithography in the semiconductor space.  With the smartphone market seeing relatively slow growth and despite Corning’s relentless push to find more points in the mobile market in which glass can be used, it will be a challenge to grow the cover glass business this year with at least one new product announcement.  Perhaps a new version of ‘Ceramic Shield’ or a UTG cover glass with superior characteristics, but smartphone size growth is relatively limited, with foldables picking up that mantra, which leads us in that direction relative to new products for specialty materials.
Perhaps we are reading more into Corning’s loose guidance for display and Specialty Materials for 1Q, but based on the display space itself and panel pricing, we are expecting the inverse of last year, when a strong 1H in the display space was followed by a weakening 2H, but we are struggling a bit to understand what the drivers for a better 2H ’22 in the display space might be, aside from typical seasonality.  We expect that even with some of the potential changes to panel pricing and demand mentioned above that the effect on Corning’s display glass businesses will lag the industry a bit, but while last year was a year in which the display industry had considerable leverage over panel buyers, this year is more likely to have real negotiations, less affected by exogenous circumstances, resulting in a more ‘normal’ balance between supply and demand, leading us to expect a bit less overall growth in the display space.