Here’s Why We Believe Cree Is Still Worth $58

by Trefis Team
-29.35%
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Cree
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Despite reporting strong earnings growth this year, Cree’s (NASDAQ:CREE) stock price has declined by approximately 40% year to date. Lower gross margin, doubts regarding the company’s capability to sustain its growth in the long term, and rising competition from bigger players such as General Electric (GE) are some of the key factors contributing to the negative sentiment around Cree’s stock.

Our price estimate of $58 for Cree is at a 40% premium to the current market price of $41. Product innovation in the last few quarters has opened new applications and improved LED returns, in turn driving additional demand for Cree’s products. The continued growth momentum, combined with a strong balance sheet, gives Cree the flexibility to respond to new opportunities in the market. 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.

See Our Complete Analysis for Cree Here

LED Adoption To Rise In The Future Driven By The Lighting Segment

With increasing global awareness about the economic and environmental benefits of LEDs, their adoption is rising at a fast pace. LEDs offer energy savings of 50%-60% over incandescent alternatives, 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, especially as economies of scale allow for lower average selling prices. The sales of LED light bulbs in America have enabled over $1 billion in lifetime energy savings for consumers. [1]

As countries around the world aim for greater economic and social development, LED adoption should accelerate in coming years. As per the 2007 Energy Independence and Security Act, it is no longer legal to produce or import 40-watt and 60-watt incandescent bulbs in the U.S. The 100-watt and 75-watt variants were phased out in 2012 and 2013. [2] Improving economic conditions, innovative new products (such as the LED bulb available for $10), and the narrowing price gap between LEDs and conventional technologies, are all key factors driving LED adoption.

The general lighting market is expected to be the primary growth driver for the LED industry. 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. [3] LED’s accounts for approximately 1% of the U.S. lighting market, and thus remain a largely untapped opportunity. [4]

Rapid Innovation Has Made Cree One Of The Leading LED Manufacturers

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 in the last few quarters 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. This places it in a strong position to leverage the growth in LED adoption.

The company hit a milestone in driving LED adoption a year back by launching an LED bulb for as low as $10. The LED bulb is considered one of the biggest industry innovations in years and has seen tremendous success at Home Depot stores. Cree’s 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. [5] Cree’s 40-watt substitution LED light (which costs less than $10) has undercut GE 40-watt substitution knob, which is available for $25 at Amazon. Additionally, while GE’s light conveys the same 450 lumens as Cree’s, it consumes 50% more power. ((Is Cree Setting Itself For Higher Growth?, guruFocus, September 28, 2014))

Downside – 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. 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. Additionally, Philips recently introduced what it believes is the world’s most vitally proficient light, which the company anticipates will be priced in line with current LEDs. The rising competition can limit Cree’s long-term growth potential. [6] If Cree’s market share remains stagnant, then our price estimate will decline by more than 10%.

Cree Can 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. 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. 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%. [7] 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.

If Cree’s gross margins decline to 35% over our review period, then there will be an  approximate 10% downside in our valuation for the company.

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Notes:
  1. Price Cuts At Cree: Expect Bulb Sales To Soar, Seeking Alpha, March 21, 2014 []
  2. Time To Bet On This LED Player For The Long Run, Gurufocus, March 29, 2014 []
  3. Can LEDs Brighten Investor Portfolios?, Investopedia, August 29, 2013 []
  4. Cree Management Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, October 22, 2013 []
  5. Cree’s (CREE) CEO Chuck Swoboda on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha, August 12, 2014 []
  6. Is Cree Setting Itself For Higher Growth?, guruFocus, September 28, 2014 []
  7. Cree Makes The Biggest Thing Since the Light Bulb Brighter and More Affordable, Cree Press Release, March 12, 2014 []
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