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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. However, rising competition from bigger players, such as Nichia Corporation, GE and Philips, can limit Cree’s growth potential in the future. Further, a tough competition from Chinese players can make it challenging for Cree to make a good profit margin and at the same time retain its market share. We forecast Cree’s Lighting market share to remain at current levels over the rest of our review period. However, if Cree might not able to maintain its market share due to an increasing competitive environment. If Cree's Lighting market share declines by 500 basis points going ahead, there can be 15% downside to out price estimate.
- Failure To Increase Gross Margins Close To The Historic Levels: Cree's Lighting products gross margin has declined from 27.4% in 2011 to 25.7% in 2015 (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 gross margins declined drastically in calendar 2015, we forecast margins to increase in 2016 and 2017, and stay around 31% 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 Lighting segment is the most valuable segment for Cree, accounting for around 39% of its overall value and over 50% of its revenues. Cree is a strong competitor in high power LED Lighting market, and we expect it to deliver strong performing products in the market.
LED Chips & Components
LED Chips & components segment contributes for 21% of value for Cree, accounting for around 35% of its revenues. Cree has been experiencing a downturn in this segment due to significant decline in LED prices.
Power & RF products
Cree's Power & RF segment contributes for around 25% to Cree's value. This is due to a incremental growth of revenues and high gross margins of Power & RF segment as compared to the LED segment. 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. The penetration of LEDs as a percentage of general illumination is expected to reach 36% and 74% by 2020 and 2030, respectively. (Link)
LEDs 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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- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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