Cree’s Stock Price Soars On Strong Q2’16 Results, But Fierce Competition In LEDs To Prevail In 2017

Leading LED manufacturer, Cree (NYSE:CREE) reported its fiscal Q2 2017 earnings on January 24th. (Fiscal years end with June.) The company’s revenues from continuing operations and its bottom-line decreased by 12% and 7%, respectively. However, these metrics came in above the consensus estimates and Cree’s previously guided range for the quarter. This led to a sharp increase in the stock price by roughly 10%, though it closed up just 5.6% as investors booked profits. It should be noted that the company’s revenues were above the targeted range primarily because of Cree’s settlement of patent infringement and false advertising lawsuit with Feit Electric. However, this gain was partially offset by additional lightning reserves because some commercial lighting products were identified as defective by a third party customer. It is worth noting that Cree’s performance, in terms of both revenues and margins, has dramatically improved on a sequential basis.

Q3 is likely to be a seasonally slower quarter for Cree. However, the company is targeting incremental gross margin improvements in Q3, driven by the lighting segment. Further, operating expenses in Q3 will be lower because of lower promotional and IP litigation spending. The operating margin improvement is likely to be slightly offset by higher R&D spending for new LED product development.

To drive its growth in the near-term, the company is focussed on achieving the following goals:

• First, gaining government approvals to complete the sale of Wolfspeed to Infineon. The company targets to complete the spin-off by the end of fiscal Q3.
• Second, driving top-line growth of the LED lighting business. To achieve this target, Cree is focused on high growth smart lighting products. Also, the company is evaluating growth opportunities in the lighting segment through potential M&A.
• Finally, improving overall operating margins. Cree believes that improvement in lighting gross margins will primarily drive overall operating margins. The company expanded its lighting product portfolio in Q3 by launching new high-value products, which it believes will help in improving margins in Q3.

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In the table below, we can see the key metrics as reported by Cree in Q2’16:

Competition In LED Products Business To Prevail In 2017

Though Cree claims that the fundamentals of its businesses have improved, we believe that competitive pressure is likely to prevail in 2017 as well. According to a report by LEDInside, the global LED market is estimated to grow by mere 3.4% annually to US$14.8 billion in 2016. The report also states that the LED industry is likely to be under tremendous competitive pressure in 2017. Another report by LEDInside states that Chinese LED packaging manufacturers have rapidly scaled up their operations since the second half of 2016. Clearly, these factors are indicative of increase pricing pressure on Cree’s LED products business, which can have negative implications on its overall margins in 2017.

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