Wednesday, January 19, 2011

Cree's Results Confirm SemiLEDs weakness

LED manufacturer Cree gave a disappointing set of Q2 results. Cree missed EPS estimates and revenue forecasts, recording 55c and $257m as against expectations of 58c and $277m. In addition Q3 guidance was below estimates. Cree forecast revenues of $245-265m and EPS of 38-45c, analysts had previously forecast $288m and 68c. What went wrong?

In the conference call Cree cited two issues...

'This was primarily due to lower sales for LED component distributors in Asia, due to an inventory correction at their customers. The inventory correction has been caused by a pause in the China LED streetlight demand and lower-than-expected growth in LED bulb applications.'
...and looking specifically at the China streetlight issue...
'The China streetlight slowdown is related to a pause in the market as new specifications were being developed by the government. The specifications were published last quarter, and a number of companies were recently approved under the new guidelines. We have design wins at the majority of these companies and expect new projects to start being awarded after the Chinese New Year. '
...turning to the LED bulb weakness...

'The LED bulb slowdown is related to our customers working off inventory that was bought in Q1 ahead of end customer demand. The application is growing, but not as fast as our customers had anticipated, which has resulted in the short-term inventory correction.'

Growth to Return for Cree?
Whilst the management made reassuring remarks about a return to growth after China restarts spending on LED street lighting, I'm not sure that this make Cree a stock to buy, even if this occurs.

Firstly, according to LEDs Magazine a smaller competitor SemiLEDS Corporation gave a warning recently. SemiLEDS warned of pricing pressure and declared the Co had lost a key account to a larger competitor solely based on price. Since, over 80% of its sales are in Asia and they are focused on general lighting (where Cree is aiming for growth)  not back lighting.  So pricing competition appears to be an industry issue, as well as current high inventory.

Secondly, whilst longer term there is a clear industry growth trend, this will not come without innovation and, this costs R & D and capital expenditure. Margins could be under pressure as Cree try to develop technologies in order to encourage demand.

Thirdly, it is still unclear whether austerity measures in Europe, let alone the US, will have an effect on LED road infrastructure spending.

Finally, there are fears that ramping up of capacity and production in the LED market has caused significant oversupply. This, if true, would likely play out in pricing pressures for Cree.

Cree Evaluation
All of which suggest a lot of uncertainty with Cree, however every stock has its price. Is Cree Good Value?

Frankly, at $62.71 I don't think so. Cree's rolling free cash flow yield is 1.44% and it trades on a trailing PE of 36. All of which could work, if I accepted the analysts five year growth forecast of 22% pa. I think that these growth assumptions are far from being assured. Whilst industry growth looks assured, it is far from clear that Cree will be able to maintain margins and market share.

I would expect the stock to get weaker from here. I like the industry but think it is too early and too expensive to get into Cree, in order to benefit from the expected resumption in Asian demand. I will monitor.


LEDs Magazine 'SemiLEDS Shares Suffer on Weak Oulook' , Accessed Jan 19, 2011

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