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Investment Overview for Cree (NYSE:CREE)
- Rising Competition Can Reduce Cree's Market Share: A general shift to LED lighting in the lighting market is expected to be the primary growth driver for the LED industry, as demand from the backlight market nears saturation. Cree is confident that it is well positioned to continue to win in LED lighting. Though the company has made significant progress growing both the volume and product base of its lighting business over the last several years, it believes that there is still a lot of untapped potential in terms of both revenue and profitability. Cree is looking to improve its brand positioning in both the commercial and consumer markets. We forecast Cree’s market share to reach close to 10% over our review period. However, rising competition from bigger players, such as GE and Philips, can limit Cree’s growth potential in the future. If Cree products loose their competitiveness in the market and the company’s market share declines to 7%, our valuation for Cree will decline by 20%.
- Failure To Increase Gross Margins Close To The Historic Levels: Cree's gross margin has declined from 48.3% in 2010 to 34.8% in 2014 (calendar year), on account of declining LED prices and increasing competition. Gross margins declined considerably in fiscal 2015 (ended June 2015), to 29.1%, primarily due to lower LED bulb margins on account of the more competitive pricing environment and the company’s decision to restructure the business to reduce excess capacity and overhead. While we forecast gross margins to decline drastically in calendar 2015, we expect margins to increase in 2016 and 2017, and stay around 34% for the rest of our review period. We believe that a higher revenue base, improving margins for LED bulbs and better cost synergies will help improve gross margins in the future. However, if Cree's gross margins remain around the 29% for the rest of our review period, there will be a 10% decline in our valuation for the company.
Cree, Inc. is a leading innovator of lighting-class light emitting diodes (LEDs), LED lighting and semiconductor solutions for wireless and power applications. Its products are used in applications such as general illumination, video displays, automotive, electronic signs and signals, variable-speed motors and wireless systems.
Its LED products consist of LED components, LED chips, LED lighting products and SiC wafers. As it develops and improves LED technology, and the market continues to focus on energy efficiency, the potential market for LED lighting will continue to expand.
LED products segment is the most valuable segment for Cree, accounting for around 70% of its overall value and over 90% of its revenues. Cree is a strong competitor in the LED market, and we expect it to deliver strong performing products in the market.
Power & RF products
Despite contributing less than 10% to Cree's revenues, Power & RF segment contributes less than 5% to Cree's value. This is due to a slower growth rate of Power & RF revenues as compared to the LED market. In May 2015, Cree announced its plan to sell-off its Power and RF business, a move that will allow the company to focus individually on its LED and lighting business sectors as well as its power and RF businesses. The company also recently acquired Arkansas Power Electronics International (APEI, which will enhance Cree’s market-leading position for SiC power electronics, infusing its Power and RF business with additional intellectual property and applications expertise at the systems level from APEI.
Lighting market is still unsaturated
With the demand from the backlight market nearing saturation, the expanding general lighting market is slated to drive LED sales in the future. LED lamp and lightning revenues are expected to rise to $74 billion by 2020, reaching a 42% unit share and a 73% revenue share of the lighting market as costs and prices fall and incandescent bans take effect worldwide. Currently, LEDs make up 10% of the total lighting market, but by 2015, this is expected to increase to 46%. A recent McKinsey report highlights that it may make up more than 50% of all lighting segments (residential, commercial, industrial, outdoor) in the next few years.(Link)
LED's cost competitiveness is increasing
With major countries promoting LED lighting, LED lumen efficiency has been improving and the prices for LED lighting are estimated to drop by 30-35% every year. This means that soon LED lighting would be an affordable option for everyone, at which point the lighting market would witness a shift from traditional (incandescent and fluorescent) sources of light to LEDs.
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