Not A CREE-dible Buy
Cree Inc. (CREE) is in a dominant position in the LED market. The company’s revenues grew 24% year-over-year (YoY) in its latest earnings announcement for 1QFY14. One of its LED products recently received the Energy Star Certification. This means it can now be sold very cheaply following an instant utility rebate which will lead to increased volumes. Cree’s revenue share from lighting products is also rising, corresponding to the overall growth of the general lighting market.
Though there is a risk of oversupply in the LED market which will affect margins, Cree’s innovative products and other strengths, such as its international presence – which it can build upon – will help the company grow its earnings.
Cree operates in the Semiconductors and Semiconductor Equipment industry. It manufactures semiconductor LED (light emitting diode) devices and materials.
The company has three product segments, namely LED Products, Lighting Products, and Power and RF Products. Out of the three, the LED Products segment contributes the most to company revenues.
This segment consists of LED chips, LED components and Silicon Carbide (SiC) materials. LED chips are used in various applications such as displays and backlights. LED components include packaged LED products like Xlamp LEDs, LED Modules and High-Brightness LEDs. Cree’s Xlamps are used in lighting applications; its LED modules provide a complete solution for lighting designers and its high-brightness LEDs are employed in applications like displays and specialty lighting.
This segment offers both LED as well as traditional lighting solutions for products such as lamps, floodlights and streetlights.
Power and RF Products
This segment makes power modules and other products that are used in the manufacture of efficient power supplies, which are then used in various devices such as UPS (uninterruptible power supply) and computer servers. The segment also makes components that are used in applications like radars and broadband amplifiers.
If we divide Cree’s segments into five major regions, the US, China, Europe, Japan and others, we see that the revenue share from the US has been growing. In 2012, it became the biggest single contributor to Cree’s revenues.
The global lighting industry – both traditional and LED – is growing, and this is spurring demand for LEDs. According to research by McKinsey & Company, Inc. published in 2012, revenues from the global lighting market are estimated to be around $160 billion by 2020, 80% of which will be made up by general lighting. McKinsey expects the share of LEDs in general lighting to reach 45% by 2016, up from 9% in 2011. The size of the LED lighting market is estimated to grow to $51 billion in 2016 and to about $92 billion by 2020. The share of LED light sources on a value basis in general lighting was 27% in 2012. This figure is expected to increase to 56% by 2016 and 77% by 2020.
Research by other companies seems to confirm McKinsey’s expectations. According to a recent report by NPD DisplaySearch global penetration for LED lighting applications will increase to 26% in 2016, up from just 5% in 2012. Furthermore, the number of LEDs used in lighting applications was about 16 million units in 2012, a number that is expected to almost triple by 2016. Research by Greentech Media indicates that the North American Enterprise LED Lighting market is growing at a rate of 40% a year through 2016 and will exceed $1 billion in 2013.
The increasing shift towards LEDs is mostly because of their efficiency and savings on power consumption. LEDs, on average, provide 60 to 90 lumens* per watt compared to a low of 10 lumens for incandescent lighting and have an average life span of 50,000 hours. Additionally, they have a score of around 90 on the CRI** and emit the least amount of carbon dioxide.
* the amount of visible light emitted by a source
** Color Rendering Index is a measure of a light source’s ability to show object colors ‘realistically’ or ‘naturally’
Governments are also increasingly encouraging the use of efficient incandescent lights and traditional bulbs to reduce carbon emissions, which is also promoting the growth of the LED market. For example, in 2007 Australia introduced new environmental regulations for 2009, which has led to a ban in the sale of incandescent light bulbs. Starting from October 2016, China also plans to ban the sale and import of light bulbs which consume more than 15 watts.
Recently, Cree got Energy Star Certification for its LED bulbs which is a certification given to a product that meets energy efficiency standards set by the EPA (Environmental Protection Agency). This rating means Cree’s energy-efficient and long-lasting LED bulb, which costs almost $10, can be sold with an instant utility rebate bringing its price down to under $5. This will increase the popularity of LEDs, especially in residential applications. More of these products and rebates will bring the industry’s payback period for investment down to two or three years, spurring further growth in sales and revenues.
Performance & Valuation
In FY13, Cree had a five-year revenue CAGR of 22% and a five-year EPS (earnings per share) CAGR of 14%. In FY13, its EPS grew more than 89% YoY. The company’s gross margins in FY13 increased by 2.6ppts (percentage points) to 37.75%.
Cree’s 1QFY14 revenues were $391 million, a 24% YoY growth. The majority of this growth was caused by higher sales of LED fixtures in Cree’s Lighting Products segment.
Cree’s GAAP EPS was $0.25, reflecting 79% YoY growth. The company’s 2QFY14 guidance estimates that revenues will fall in the range of $400 million to $420 million, and EPS will be between $0.36 and $0.41. Cree’s future growth will continue to come from the sale of LED fixtures and bulbs.
Cree’s stock price has fallen around 20% since company guidance was expected to be at a midpoint of $414 million in revenues and $0.44 in EPS. The guidance had been lowered following an increase in operating expense guidance to $5.5 million in the first quarter majorly due to advertising expenses and suppression of margins in lighting products which fell from 31.6% in 1QFY13 to 26.9% in 1QFY14.
The stock is currently trading at one year forward P/E multiple of 42x, with a three year EPS CAGR of 30% and a three year revenue CAGR of 24%.
Cree’s Relative Stock Performance
In the last 12 months, Cree’s stock has outperformed the iShares PHLX Semiconductor ETF (SOXX). Cree’s one-year return was 109% while SOXX’s one-year return was only 33%.
The LED industry is growing, but currently faces an oversupply problem which is causing a dip in margins. According to IHS, the supply of LEDs is expected to exceed demand by 69% in 2013 and in 2014 but will decline to 61% and then 40% in 2015 and 2016 respectively. Margins are also likely to stay depressed until more innovative products are released, since currently most the market offerings are homogeneous.
Asia is slated to become a major consumer and supplier of LEDs and while currently Cree’s growth is coming mostly from the US and it needs to further build on its exposure in emerging markets to grow future revenue streams.
Because of these industry restraints Bidness Etc is neutral on the stock while keeping industry trends under review. If there is any shift in government regulations or over-supply leading to pricing pressure along with a slowdown in emerging markets, Bidness Etc may recommend going short on the stock.
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