Cree’s Earnings Preview: Trends To Watch

by Trefis Team
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Despite sluggish macro trends, Cree (NASDAQ:CREE) marked a strong start to its fiscal 2013 with a 60% sequential increase in net income, though revenue increased by a mere 3% in Q1 2013. The company is set to announce its Q2 2013 earnings on January 22. While the short-term growth remains sluggish, we remain optimistic of the long-term potential in the LED market.

A LED surplus, a consequent decline in prices and pressure on margins are some of the key trends currently plaguing the LED industry. While a demand-supply mismatch has put pressure on Cree’s topline, high R&D cost and operating expenses threaten its bottom line.

Witnessing an increase in orders for all its business division, Cree claims that the LED market dynamics are improving. With increasing awareness about the economic and environmental benefits of LEDs, its global  adoption is bound to increase in the future. Being one of the leading players, we believe Cree is in a strong position to leverage growth in the LED market.

See Our Complete Analysis for Cree Here

Potential Growth In The LED Market

The increase in LED supply led by Chinese manufacturers resulted in the LED surplus rising from a relatively low 7% in 2010 to 45% in 2011. With the demand from the backlight market nearing saturation and the general lighting market yet to take off, growth in demand has been slow, resulting in a huge demand-supply gap that has put pressure on the average LED selling price.

Nevertheless, the LED market has more than doubled in size in the last 5 years from $5 billion in 2006 to around $12.5 billion in 2011. We estimate the market to grow at a CAGR of 8% going forward and reach approximately $24 billion by 2019. While LEDs currently account for only 10% of the total lighting market, the percentage contribution is estimated to increase to as high as 60% by 2020. [1]

With energy savings of 50%-60% leading to lower greenhouse gas emissions and a much higher lifespan compared to conventional technologies, LEDs offer a cost effective option to lower global electricity consumption.

Continuous Innovation Can Help Cree Increase Market Share

Cree remains committed to drive LED adoption by optimizing performance and lowering costs to narrow the gap with conventional lighting. It intends to remain focused on investing in new product development and initiatives to drive product sales, factors which will help it regain its growth momentum in the future.

Cree witnessed an increase in orders for both the lighting and LED segments in the last quarter of 2012 which translated into higher revenues in Q1 2013. Witnessing improvement from both the agent and direct sale channel, Cree’s lighting sales grew by 7% and the LED sales increased by $2 million sequentially.

As the backlight market nears saturation, the potential growth in the general lighting market is expected to fuel LED demand. Cree’s lighting sales delivered the strongest growth last quarter backed by growing LED lighting adoption and regained agent momentum. Cree expects to see strong growth in the lighting segment in the future, and we believe its acquisition of Ruud Lighting better equips the company to leverage growth in this segment.


Increasing Stability In Gross Margins

While Cree’s gross margins increased significantly in 2010, they declined close to the historical level of around 37% in 2011. The downward pressure resulted from a combination of decreasing selling prices and high operating expenses as Cree stepped up R&D efforts to close down LED gap with traditional lighting. However, after eight quarters of consecutive declines in gross margin, Q3 2012 offered some respite with a slight increase in margins. While margins remained flat in Q4 2012, they rebounded to 37.5% in Q1 2013.

While Cree continues to make incremental investments each quarter, a decline in factory costs, higher yield improvement and the introduction of new lost cost products, both in LEDs and lighting, have somewhat eased the pressure on margins. Though there continues to be a lack of visibility on future demand, Cree looks optimistic of further increasing its factory efficiency and improving margins.

As the adverse macro conditions subside and demand picks up, higher revenues for a similar cost base would lead to a marginal increase in margins. However, with the shift in product mix toward lower margin fixtures and a potential increase in competition, we expect margins to remain more or less around the same level.

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Notes:
  1. Lighting the Way: Perspective of the global lighting market, McKinsey Report []
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