This blog is devoted to helping investors make informed decisions. It will be regularly updated and provide opinions on earnings results. It is not intended to give investment advice and should not be taken as such. Consult your investment advisor.
Cree$CREE
recently gave a mixed bag of results although the market sent the stock
sharply higher. This is probably due to the fact that -- for the first
time in five quarters -- Cree beat market estimates and because the
stock went into relief rally mode. In summary, whilst the results were
mixed for Cree, I think there is enough "color" in the numbers and in
the surrounding commentary to produce some useful takeaways for the
industry at large.
The "relief rally" argument carries more weight if you recall that
LED demand has low visibility and is subject to short lead times. Throw
in the weaker macro economic environment in the quarter and there would
have been a high degree of variability in investor expectations for the
quarter. No matter. Cree delivered and in doing so it demonstrated that
it had largely cleared up the agency issues that dogged lighting sales
for the company in the previous quarter.
On the other hand, the guidance for the next quarter was weaker than
market estimates, LED prices continue to fall, markets remain extremely
competitive, the uncertainty of China’s stimulus spending remains (not
to say Cree’s opportunity to benefit from it) and industry capacity
remains under utilized.
Agency Issues, Lighting Sales and Gross margins
Returning to the previous quarter Cree suffered some weakness in
lighting revenue due to major changes in agency sales operations.
Essentially around 80% of Cree’s agents shifted around the types of
products they were selling and this caused disruption. This was a
disappointment because lighting appears to have the best prospects
within the industry.
LED prices are falling and quality is improving so LED based lighting
products are approaching initial cost parity with traditional forms of
lighting. This is important because many customers have ignored the fact
that LED lights offer higher quality lighting require less maintenance
and offer quicker payback in favor of buying traditional lighting
because the upfront cost is less. With regards the agency issue,
lighting sales came back strongly and it seems that the issues are
largely resolved.
Cree stated that it was targeting ‘pretty significant’ growth in
lighting and if we look at what competitors (within the lighting
segment) Acuity Brands$AYI and Hubbell Inc$HUB-A
are reporting, this part of the industry looks set for strong growth.
Acuity reported a 6.4% increase in sales in the last quarter and Hubbell
reported a 10% increase. In my opinion, Acuity remains the best play in
the overall sector. With Acuity you get exposure to the North American
residential, commercial and industrial lighting sectors and I like the
outlook for construction in the US. Hubbell is also attractive but this
company is more cyclically exposed to industry.
One area where Acuity and Hubbell have an edge over Cree is that they
have been selling traditional lighting products so shifting customers
into LED based solutions will be relatively easier for them. For
example, many developers already use LEDs for difficult to reach areas
which are expensive to maintain. Now these same developers can look at
LED solutions as being cost effective all over a development. And Acuity
and Hubbell are there to tell the story.
General Electric$GE is also going to help spur demand and awareness via their LED bulbs which are available in outlets like Home Depot $HD.
Indeed, its new LED bulbs are priced at a comparable cost to
traditional lighting. This is only a small part of GE’s operations but
there is no doubt that with its muscle behind LED adoption, the
penetration rates will increase markedly.
Turning to gross margins, I always think this is the key to decoding
when an inflection point has passed. Here are the reported numbers for
Cree.
It looks like we are bouncing along the bottom, but Cree’s management
did spend an inordinate amount of time on the conference call outlining
how on an adjusted basis they were improving. That said the stated
reason for the adjusted uptick was that it was due to factory cost
reductions, new products and process improvements. In other words, it
wasn’t really about the kind of supply/demand imbalance which will lead
to a sustained increase in the future.
The key to longer term growth will come from a sustained pick up in
demand and a new wave of adoption of LED technology in the way that flat
screens or solar power drove previous booms. The other imponderable is
China and its stimulus spending.
China to Spur Demand?
Cree did have a big street lighting win in the quarter and there is
no doubting China’s commitment to utilizing energy efficient
technologies like LEDs in a wide range of applications. However, there
is also no doubt that the timing and willingness of China to invest is
subject to uncertainty. A lot of projects tried to use domestic LEDS and
they failed, whilst this implies that Cree –as a higher quality
manufacturer- should see great benefits going forward, we need to
consider a few things. China is not the US. It is not ruled by a
democratic and liberal free market consensus handed down from generation
to generation. They are Communists.
It strikes me that maintaining employment, developing export
industries and supporting their own companies are the Government’s main
focuses. So when it comes to street lighting it is entirely feasible
that they will wait until they feel domestic producers can supply them
with the quality they want and then the spending will start.
Unfortunately, that scenario is not ideal for Cree.
One company that may fair better out of this is Veeco Instruments Inc$VECO
which provides capital machinery to manufacturers. In the end, it
doesn’t really care where or who is making the LEDS just as long as they
are doing it with Veeco’s manufacturing solutions. Veeco’s key end
driver is capacity utilization by its end customers and the company
recently talked of a gradual order recovery in the second half of 2012.
Where Next For Cree?
A quick look at the sequential movement in revenues suggests that
this was a decent quarter for Cree but if we take the midpoint of next
quarter guidance for $305-320 million in revenues, it is only a 1.9%
increase. This is low by Q1 standards and doesn’t inspire a lot of
confidence.
Longer term, the LED industry is very attractive and in particular
lighting looks set for strong growth. Cree’s stock is certainly not
expensive on a cash flow basis and a strong case could be made for some
upside potential but I would exercise a bit of patience before chasing
the stock higher.
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