Cree: Quick Recap of 2014 & Why We Believe The Stock Could Do Better

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CREE
Cree

Leading LED manufacturer, Cree (NASDAQ:CREE) has seen its stock decline by almost 50% so far this year. Lower gross margins, doubts regarding the company’s capability to sustain its growth in the long term, and rising competition from bigger players are some of the key factors contributing to the negative sentiment around Cree’s stock. Though the company reported strong double digit growth in the first half of calendar 2014, its growth in fiscal Q1 2015 (calendar Q3 2014) significantly slowed down on account of weak LED sales. (Fiscal years end with June.)  Lower LED revenue and a higher mix of lighting sales (which have comparatively lower margins) resulted in a seven percentage points year-on-year decline in the company’s gross margin last quarter, which led to 63.5% decline in its net income.

Lower LED demand and margins are two keys trends impacting Cree’s near-term growth prospects. Cree plans on  lower inventory levels and reduced capital expense in Q2 2015, as it plans to reduce the LED factory production rate (in line with demand) to support higher free cash flow over the next several quarters. In tandem, it aims to return to positive cash flow in the ongoing quarter with this reduction in both its working capital balances and its capital spending.

Our price estimate of $41 for Cree is at a significant premium (~25%) to the current market price. We continue to believe in the company’s long-term growth potential. The continued growth momentum, combined with a strong balance sheet, gives Cree the flexibility to respond to new market opportunities.

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See Our Complete Analysis for Cree Here

Lighting Segment To Drive Future Growth In LEDs

With increasing global awareness about the economic and environmental benefits of LEDs, their adoption is rising at a fast pace. LEDs offer a cost effective option to lower global electricity consumption, especially as economies of scale allow for lower average selling prices. LED bulbs are approximately 80% more efficient than the incandescent light bulb. The Department of Energy estimates that 300 terawatt hours of energy could be saved by the U.S. by 2030. [1] The sales of LED light bulbs in America have enabled over $1 billion in lifetime energy savings for consumers. [2]

A general shift to LED lighting market is expected to be the primary growth driver for the LED industry, as demand from the backlight market nears saturation. The LED backlighting market is expected to continue declining, as prices decline further and newer TVs require fewer LEDs. On the other hand, the LED lighting market is anticipated to grow 45% per year through 2019, driven by the declining price points and the rising interest on the part of  the channel in pushing LEDs to consumers. LED lighting is expected to account for 80% of the entire lighting market by 2020, creating a market that will be worth as much as $94 billion. [3] As reported in Digitimes, Taiwanese supply chain firms expect the total value of LED lighting output to rise 30% next year, with a doubling of shipments more than offsetting 30%-35% price drops. A recent McKinsey report highlights that it may make up more than 50% of all lighting segments (residential, commercial, industrial, outdoor) in the next few years. ((Cree Inc. May Soon Become Interesting, Seeking Alpha, December 14, 2014))

Continuous Innovation Can Help CREE Leverage LED Growth

Cree is one of the leading LED players committed to driving global LED adoption and closing down the price gap with conventional lighting through innovation. Product innovation over the last few years has opened new applications and improved LED returns, in turn driving demand for Cree’s products. The company has a fully integrated vertical business model and is the market leader in both LEDs and LED lighting products.

The company hit a milestone in driving LED adoption a year back by launching an LED bulb for as low as $10. Cree’s LED bulb is the best selling LED bulb in the U.S. and has helped establish the Cree brand as the leader in LED consumer lighting. [4] Cree recently announced the ZR high efficiency troffer which is the first commercially available 150 lumens per watt LED troffer in the market. This product utilizes Cree TrueWhite Technology and reduces energy consumption by 70% when compared with traditional fluorescent troffers and is fundamentally more efficient than competing LED products. The company is also developing a next generation consumer LED bulb that delivers even better light and looks even more like a regular light bulb, all at a price that gives more people a reason to switch to LED. ((Cree’s (CREE) CEO Chuck Swoboda on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha, August 12, 2014))

Cree is working on its next generation LED technology platform that it believes will enable it to redefine high power LED performance. The new platform more than doubles the lumens per LED, incorporating significant advances in the epitaxial structure and chip architecture, as well as including an advanced light conversion system. The first products based on this platform are expected to be announced in the near future;  initial samples should be available later this quarter and the first production devices should ship in fiscal Q3 2015.

Additionally, as we wrote in August, Cree’s recent collaboration with Lextar, can help expand its footprint in the mid-power LED segment. Lextar is a vertically-integrated LED company and has a strong technology position and customer base in the mid-power backlighting LED segment. Cree, on the other hand, offers outstanding performance in the high-power LED component and lighting market.

Rising Competition From Bigger Players Can Limit Growth Potential

Osram, Philips and GE are some of Cree’s key competitors in the LED market. In terms of revenue, all these players are considerably larger than Cree. Philips and GE have been introducing a number of innovative products into the market at very low prices, although Cree bulbs are still one the cheapest available in the market. The sheer size of GE can help the company achieve economies of scale if it chooses to create LEDs on a vast scale in the future. GE sells its LED bulbs through Wal-Mart, which has a huge network of 11,000 stores spread across 27 countries. In comparison, Cree’s retail partner Home Depot has around 2,300 stores. ((Why Investing In Cree Looks Like A Bad Idea, Seeking Alpha, December 3, 2014))

The rising competition can limit Cree’s long-term growth potential, and the company clearly needs to focus on innovation in order to capture the growing market. We expect CREE to continue growing, but project the growth rate to slow down over our review period. Cree is part of an industry that is still at a nascent stage of growth and a continuous focus on bringing new low-cost and more efficient product in the market can help it expand its revenue base in the future.

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Notes:
  1. Cree Inc. May Soon Become Interesting, Seeking Alpha, December 14, 2014 []
  2. Price Cuts At Cree: Expect Bulb Sales To Soar, Seeking Alpha, March 21, 2014 []
  3. Why Investing In Cree Looks Like A Bad Idea, Seeking Alpha, December 3, 2014 []
  4. Cree’s (CREE) CEO Chuck Swoboda on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha, August 12, 2014 []