Cree (NASDAQ:CREE), a market leading manufacturer of LED products, is set to announce its Q4 2012 earnings on Tuesday, August 7. Plagued by persistent oversupply and consequent pricing pressure in the LED market, the company posted weak Q3 2012 results. While research firm IMS estimates the LED surplus to remain prevalent for the rest of the year as well, Cree claims that its LED component sales improved post-Chinese New Year, and thus targets an improved market demand for the remaining part of 2012.
The company registered an improved order rate for all of its product lines – LED, Lighting and Power & RF. We believe that as Cree revives from the temporary agent transition setback, which occurred in January 2012, and new product innovations fuel demand for lighting, the company can register a marginal growth in Q4 2012. Here, we list down certain factors that justify our positive outlook for the company.
Lutron Partnership Could Drive LED Lighting Growth
Earlier in May this year, Cree announced a first of its kind agreement with Lutron Electronics where the two companies joined hands to introduce the world’s most efficient lighting control and delivery system by embedding Lutron’s technology on a chip in Cree’s luminaries. Cree witnessed over 150% growth in LED revenues since 2007 and the company hopes to further accelerate LED adoption and increase energy efficiency among designers, contractors and owners.
The lighting market remains unsaturated and is expected to generate significant growth for the LED industry. We estimate the LED market to grow to US$10 billion in 2012, up almost 100% from US$5 billion in 2007. With major countries promoting LED lighting, LED lumen efficiency has been improving and the LED lighting prices have come down over the years, making it an affordable alternative and marking a shift from traditional (incandescent and fluorescent) options to LEDs.
The alliance with Lutron can break new ground for LED fixtures and control systems as the integrated system can improve performance across the board with increased efficiency, lifetime and payback. We believe that the agreement with Lutron can take Cree a step further in its goal to increase LED adoption globally.
New Technology Centers to Leverage Growth in China
This quarter, Cree also increased its presence in the Chinese market with new technology centers that cater to the unique requirements of Chinese lighting manufacturers. The company further expanded its thermal, electrical, mechanical, photometric and optical (TEMPO) services, providing manufacturers with a complete set of evaluation services for LED luminaires to design and market quality LED products. Also, the company was part of China’s largest municipal lighting control project with more than 1.9 million XLamp LED lights, lighting up over 20,000 street lights in China’s Beibei district. (Read: Cree’s Growth Potential Shines With 20,000 LED Street Lamps In China)
Holding the world’s largest population and being one of the fastest growing economies, China is expected to have rapid infrastructure expansion with the government focusing on increasing industrial and commercial development. According to LEDinside, while the Chinese lighting market constituted close to 15% of the global market share around 2010, it predicts the same to reach around $20 billion, constituting 18.3% of the global market by 2015. 
Cree derives approximately 36% of its revenues from China, and we feel that increasing its presence in the Chinese market augurs well for the company’s valuation.
Steady Gross Margins
The company’s gross margin saw a significant increase from around 32% in 2007 to a high of 48% in 2010. However, owing to depressed prices, the gross margin witnessed a downward pressure and dropped to 37% in 2011. With the shift in product mix toward lower margin fixtures and a potential increase in competition as LEDs gain ground with the traditional incandescent light bulbs and CFL technology users, we expect the margins to be more or less around the same levels.
Despite certain roadblocks, Cree seems to be making the best of the tough LED market. Its LEDs score high on performance benchmarks like color consistency and high brightness across a wide viewing area. Its acquisition of Ruud Lighting, a leader in outdoor lighting, in mid-2011, allows Cree to extend its leadership position and increase the adoption of energy-efficient LED lighting. It also gives the company a broader presence in the lighting systems market and the expertise to develop the next generation of industry-leading, lighting-class LED components. We believe that increased investment in R&D and developing newer products to differentiate itself from other competitors will help Cree improve cost and performance to drive LED adoption.
Our price estimate of $27.50 is at a premium of above 10% to the current market price.Notes:
- China’s LED Lighting Market Trends, Outlook and Forecast 2011-2015, LEDinside, October 13, 2011 [↩]