Cree’s Growth Prospects Remain Bright Though Gross Margins Remain Under Pressure
Leading LED manufacturer Cree (NASDAQ:CREE) is set to report its Q4 2014 and fiscal year 2014 earnings on August 12. (Fiscal years end with June.) Having witnessed slow growth in 2012 (calendar year), the LED market dynamics improved considerably in 2013, primarily driven by the launch of new innovative products and the closing price gap with traditional lighting. Product innovation in the last few quarters has opened new applications and improved LED returns, in turn driving additional demand for Cree’s products. Its revenue and net income for the first three quarters of fiscal 2014 are 20% and 61% higher compared to the same period last year. The company believes that it is well positioned to grow in the current quarter as well.
Despite strong top line growth in the last few quarters, Cree’s stock price has declined more than 20% year to date. We believe the pressure on gross margins, on account of the rising proportion of lower margin lighting sales, led to the negative sentiment around the stock.
Nevertheless, we believe in Cree’s long term growth potential. LED penetration is expected to increase in the future, and being one of the leading global LED manufacturers, Cree will benefit from the trend, in our view. With $1.1 billion in cash and no debt, the company has a strong balance sheet, which gives it the ability to invest in growing its business and respond to new market opportunities.
Our price estimate of $63 for Cree is at an approximate 30% discount to the current market price. We will update our valuation after the Q4 2014 earnings release.
See Our Complete Analysis for Cree Here
Cree Can Manage To Increase Its Gross Margin
The rising proportion of lighting sales puts pressure on Cree’s overall gross margin as lighting products offer lower profit margins compared to LED components. Cree’s overall gross margin declined from 38.1% in Q3 2013 to 37.0% in Q3 2014 as the proportion of lighting sales increased from 37.4% to 43.6% of total sales during the same period. In Q3 2014, Cree earned a 27.4% gross margin on lighting products as compared to a 45.6% gross margin on LED components. A higher proportion of revenue from the fast growing lighting LED market is expected to put additional pressure on Cree’s gross margin in the future.
Cree’s LED lighting gross profit and margin growth last quarter was slower than revenue growth due to the full quarter of LED bulb sales this year compared to Q3 2013. The LED bulb price reductions offset a more favorable lighting mix. The company has lowered the prices of the Cree LED Bulb product line by as much as 23%. [1] However, Cree claims that the gross margin earned on LED bulbs will improve as it focuses on reducing the LED bulb cost.
Though margins could remain under pressure in the short term, we believe Cree can manage to increase its gross margins in the future. Higher LED volumes combined with lower new cost products, cost reductions and higher factory utilization will help increase Cree’s overall gross margin. (Read: Here’s Why Cree Can Manage To Increase Its Gross Margins)
An Expanding LED Portfolio Will Aid Cree’s Growth
Cree is one of the leading LED players committed to driving global LED adoption and closing down the price gap with conventional incandescent lighting through innovation. Product innovation in the last few quarters has opened new applications and improved LED returns, in turn driving demand for Cree’s products.
Cree hit a milestone in driving LED adoption a year back by launching a LED bulb for as low as $10. The LED bulb is considered as one of the biggest industry innovation in years and is experiencing tremendous success at Home Depot stores. Last quarter, the company added a 75-watt LED bulb (consumes 84% less energy and provides similar levels of brightness compared to traditional incandescent bulbs) as well as a 100-watt replacement bulb, which at $19.97 is the lowest-priced 100-watt LED replacement bulb.
Driven by a full lighting season, utility rebate, new products and increased marketing activities, Cree’s LED bulb sales to consumers doubled sequentially in Q2 2014. The company claims that its LED bulb gained additional momentum and brand recognition in Q3 2014. It is reinvesting most of its profits to fund additional marketing investments and generate more awareness for its LED bulb.
Cree has a fully integrated vertical business model and is the market leader in both LEDs and LED lighting products. This places the company in a strong position to leverage the global shift to LED lighting. LED lighting accounts for 15%-20% of the global lighting market at present and the LED market share is expected to rise at a rapid pace over the next decade. [2] Cree’s products continue to raise the bar in LED price performance.
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Notes:- Cree Makes The Biggest Thing Since the Light Bulb Brighter and More Affordable, Cree Press Release, March 12, 2014 [↩]
- Can LEDs Brighten Investor Portfolios?, Investopedia, August 29, 2013 [↩]