Raising Cree’s Estimates On Brighter Forecast And Model Changes

-22.09%
Downside
80.07
Market
62.38
Trefis
CREE: Cree logo
CREE
Cree

Leading LED manufacturer Cree (NASDAQ:CREE) has seen its stock price climb up by 200% in the last 10 months from approximately $25 in October 2012 to $75 by August 2013. The stock is currently trading at $57 which marks our valuation at a 10% premium to the market price. Despite reporting strong Q4 2013 results, Cree’s stock price declined drastically as its Q1 2014 outlook was below analysts’ expectation.

In the back half of 2012, the global LED market was characterized by a demand-supply mismatch which put pressure on Cree’s top line. Additionally, the high R&D cost and operating expenses incurred to increase LED penetration in the general lighting market put pressure on the company’s bottom line. However, with an improvement in supply conditions and rising demand due to narrowing price gap between LED and traditional lighting, new applications and improved LED payback, Cree has seen its growth accelerate in the last few quarters.

In addition to an improving market and company outlook, certain changes in our methodology is responsible for the significant increase in our price estimate for Cree. In this article we highlight the key factors behind our revised price estimate for the company.

Relevant Articles
  1. 9% Drop In Cree Stock A Buying Opportunity?
  2. Strong Demand Revival Could Help Cree Stock Regain Recent Highs
  3. Cree Stock Seems Overpriced After 2.5X Move
  4. Could Cree Stock Drop To $80?
  5. What’s The Downside On Cree Stock?
  6. Cree Stock To Drop More Than 20%?

See Our Complete Analysis for Cree Here

1. Expanding Global LED Market: We Expect Faster Growth

In our latest model we estimate the global LED market to cross $27 billion by the end of our review period, as against our earlier estimate of $16 billion.

With widespread awareness about their economic and environmental benefits, the adoption of LEDs is rising fast. LEDs offer 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, and as economies around the world aim for greater economic and social development, we expect LED adoption to accelerate in the future.

Cree reported strong sales in lighting as well as LED components in its fiscal 2013. The launch of innovative new products and improving LED payback has increased LED penetration in the general lighting market, in the last few months. Being one the leading LED manufacturer, the robust growth in Cree’s top line in the last few quarters make us believe that the overall LED market can expand faster than we originally anticipated. Improving macro situation, innovative new products (such as the LED bulb available for $10) and narrowing price gap between LEDs and conventional technologies are key factors driving LED adoption.

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]

2. Cree’s Market Share Can Reach 13%

We now forecast Cree’s market share to reach 13% by the end of our review period, as opposed to our initial estimate of 10.75%.

With the acquisition of Rudd’s portfolio in 2011, Cree has became the market leader in both LEDs and LED lighting products. While LED lighting products accounted for only 19% of Cree’s total revenue a year ago, they now account for as high as 35%. As the demand from the backlight market nears saturation, the general lighting market is expected to be the primary growth factor in the LED industry. According to LED Inside, the LED lighting segment is estimated to increase from around $1.5 billion in 2012 to approximately $8 billion by 2015, a CAGR of over 70%.

In its recent earnings call, Cree announced that it is still at a nascent stage of transition in LED lighting and thus the segment offers tremendous growth opportunity to the company. It has made great progress ramping up its LED bulb since its launch this year. Available for as low as $10, Cree’s LED bulbs consume 84% less energy and provide similar levels of brightness compared to traditional bulbs. In the long run, it aims to drive mass LED adoption and achieve 100% upgrade to LED lighting by its customers.

Last quarter, Cree launched two new breakthrough products which it believes will open significant new markets to LED lighting – UR Series linear upgrade kit and the first $99 LED streetlight. We think Cree is in a strong position to leverage growth in the LED market as it remains committed to drive LED adoption by optimizing performance and lowering costs of LED products.

3. Improving Gross Margins In The Future

We initially estimated Cree’s gross margin to remain flat at the current level for the rest of our forecast period. However, we now expect gross margins to improve from 39.8% to 44.9% for LEDs, and 40.4% for power and RF products.

Despite a very competitive market environment, Cree’s gross margins in 2013 improved due to better factory utilization on account of rising LED demand, process improvements and new lower-cost product designs. Cree continues to make incremental R&D investment each quarter and anticipates higher operating expenses in the current quarter, to remain competitive in the market.

However, we expect Cree’s marketing expense to decline in the future. The full quarter benefit of LED bulb cost reductions implemented during Q4 2012 and increasing shift in product mix towards higher-margin LED fixture sales, will lift margins going forward. Additionally, the company claims that the gross margins earned on LED bulbs is improving. Higher LED volumes and lower cost from new product designs will help improve gross margins in the future.

4. Miscellaneous – Tax, Capex & Cash Base

We reduced the effective tax rate from 18% to 14% (in line with company guidance) and our capex estimate from 13.9% to 11.3% of gross profit. Cree’s capex declined by more than 50% in 2012. We expect capex as a percentage of gross profit to remain way below the historical average of over 30%. Cree recently acquired Ruud Lighting and set up new factories in China. Thus, we do not forsee much investment for the next few years.

Cree continues to have a strong balance sheet with no debt. It the last 10 months its cash balance has increased from $745 billion to $1 billion as of July 2013.

5. Change In Methodology

In our earlier model, we were not subtracting the D&A figure from indirect expenses. We now exclude D&A expenses while calculating indirect costs which significantly increases the cost profits for all divisions. Thus, the total valuation for each division is comparatively higher in our updated model, which is an important factor behind the increase in our price estimate for Cree.

Understand What Drives a Stock at Trefis

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