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Cree Looks Like a Solid Long-Term Buy

May 12, 2014 | About:
Vinay Singh

Vinay Singh

5 followers

LED specialist Cree (CREE) crashed after the company's guidance for the current quarter turned out to be weaker than expected. Cree's management is looking to capture more market for its LED products, a space where bigger players such as General Electric and Philips also operate.

This is the reason why Cree is stepping up its marketing efforts, but unfortunately, the Street doesn't seem to be recognizing this. Analysts put their earnings expectations for the ongoing quarter at $0.44 per share, but Cree's management guided in the range of $0.36 to $0.41 per share. This looks like a big miss, but the long-term prospects still look good.

A Huge Market and Solid Products

Cree operates in a market that's expected to see annual growth rates of 34% till 2016 and then 13% till 2020. By 2020, the LED lighting market is expected to be worth $94 billion, according to McKinsey, and Cree looks well-positioned to tap this opportunity through its products.

Cree's 40-watt replacement LED light bulb, which costs $9.97, is priced below rival products such as those from General Electric. In addition, Cree's bulb is more efficient, delivering the same 450 lumens as GE's light but consuming 50% less electricity. In addition, Cree's recently launched XSPR Series Street Light that costs $99 is expected to make replacing sodium street lights cost-effective and 65% more energy-efficient.

Cree has been seeing good order momentum for the past few quarters and the trend continued in the previous one as well. The company is expecting growth across all its business segments in the present quarter. Management believes that the company is in a great position to take advantage of the growing popularity of LED lighting and it certainly has the right products to tap this market.

Aggressive marketing moves should add momentum to Cree's already flourishing business. Its quarterly results weren't bad at all, as revenue grew 24% from the prior-year period while net income spiked 89%. But to remain competitive, Cree will have to keep churning out innovative products and also undertake efforts to make the public aware about them. And it seems to be progressing well on both counts.

Competition on the Way

However, Cree should brace for competition from the likes of Wal-Mart (WMT), which recently made an aggressive move into the LED light bulb market. Wal-Mart recently announced its "Great Value" range of LED bulbs that would retail for under $10 in all its stores in the U.S. and also Walmart.com. Wal-Mart claims that these bulbs would be 80% more efficient, discharge 40% less heat, and last 25 times longer than a traditional light bulb.

Wal-Mart is a behemoth with thousands of stores in the U.S., and its move into selling LED bulbs for a competitive price could hurt Cree. However, Cree's bulbs sell at home-improvement retailer Home Depot, which has a footprint of 2,258 stores in 50 states. This partnership has proven fruitful so far, as evidenced by the revenue jump in the previous quarter.

Catalysts Ahead

Cree's LED bulb won the 2013 Innovation Award at Home Depot last month and the home-improvement retailer is quite impressed by how Cree's offerings have been doing. According to Home Depot management, the Cree TrueWhite bulb "gives out some of the best natural color when compared to other LED bulbs in the market." Hence, Cree is finding good traction through Home Depot.

In addition, Cree has also earned the Energy Star qualification for its LED bulbs. This means that its bulbs now qualify for utility rebates through certain local utilities. This qualification and the accompanying rebate can further drive adoption of Cree's LED bulbs and help it compete against Wal-Mart's forthcoming challenge.

Another fact that could aid Cree's growth is the possible ban on traditional 40- and 60-watt bulbs. Last year, the government had banned 100-watt incandescent bulbs, and according to USA Today, a similar fate now awaits the smaller sizes. Cree offers a 10-year guarantee on its bulbs that could last as long as 22 years, apart from saving electricity.

Fundamentals

One thing that investors need to keep in mind is Cree's steep valuation. At a P/E ratio of 67, Cree is not the ideal pick for value investors. But those who are looking for growth should certainly take a closer look at it. The stock commands a premium because Cree's earnings are expected to grow rapidly.

This fiscal year, analysts are expecting earnings to grow 24%, followed by 35% next year. In the next five years, Cree's earnings are expected to grow at a CAGR of 15.5%. Due to such strong growth projections, Cree's forward P/E is just 26x. In the previous quarter, the company's earnings were up 89% year over year and this is why investors looking for growth shouldn't be scared of its steep valuation.

Conclusion

Cree has successfully grown its business in a market despite the presence of more illustrious players such as General Electric, Koninklijke Philips, OSRAM, etc. Cree's continuous focus on innovation has helped it gain lighting orders, and the company is also undertaking a series of cost-reduction programs to bolster its margins.


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