Underlying Reasons Behind Declining Profitability of Cree

by Trefis Team
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Leading LED manufacturer, Cree (NYSE:CREE)   reported flat revenues in fiscal 2015. (Fiscal years end with June.) Further, the company’s gross margins declined from 35% in 2014 to 28% in 2015. As a result, Cree’s overall profitability declined from $95 million in 2014 to negative $123 million in 2015. There hasn’t been much improvement in the company’s growth in the first half of 2016 either. In this analysis, we discuss the key reasons that can be attributed to the declining profitability for Cree.

Subsidies From Chinese Government

With the help of government subsidies, Chinese LED manufacturers have been able to significantly expand their manufacturing capacities in recent years. Consider the subsidy provided by the Chinese government on the installation of MOCVD (Metal Organic Chemical Vapor Phase Deposition) reactors, which has resulted in lower barriers to entry in the LED manufacturing industry. MOCVD is a technique for depositing thin layers of atoms onto a semiconductor wafer that requires high upfront cost. However, the subsidies provided by the Chinese government has made the installation of MOCVD units cheaper, as a result of which the installation volume was highest in the region in 2015. The resulting supply glut caused by an excess manufacturing capacity in the LED industry is responsible for putting a strong downward pressure on LED prices. This is one key reason due to which Cree’s margins have significantly declined in recent years. In the chart below, we show MOCVD installation volume according to the regions in 2015:

MOVCD_Installation_vol

Source: LEDInside

Cree’s Choice of SiC Substrate

The two primary substrates that are currently used in LED fabrication are Sapphire substrate and Silicon Carbide (SiC) substrate. Cree is the only LED manufacturer that uses SiC as its substrate. LEDs based on SiC substrate are expected to have longer lifetime as compared to LEDs based on the Sapphire substrate. This comes from the fact that there is a larger mismatch in the crystalline lattice structure of a Sapphire substrate as compared to that of a SiC substrate.

However, none of the disadvantages of a Sapphire substrate are that critical. In fact, the high availability of low cost sapphire makes the production of LEDs cheaper. Furthermore, there is high industry expertise to produce LEDs based on Sapphire substrates. According to a report, around 96.3% of LEDs produced in 2015 were based on Sapphire substrate. The same report also predicts that the use of Sapphire in LEDs would further rise to 96.7% by 2020. The increased use of Sapphire substrate in the LED production is making it difficult for Cree to compete with other players on price points. This can be another reason behind the declining profitability of Cree.

We are in the process of updating our model for Cree.

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