Tuesday, June 3, 2008

Taking a look at CREE

Cree, Inc. makes compound semiconductor materials and electronic devices of silicon carbide (SiC). Light emitting diodes (LED) account for 78% of revenues; other SiC products, 14%; government funding, 8%. Explores new materials systems such as gallium nitride (GaN) and aluminum nitride (AlN). Sumitomo accounted for 24% of fiscal 2007 revenues.

Cree is starting to show improvement. The company earned $0.11 a share in the fiscal second (December) quarter, its first year-over-year increase since 2005. Revenues have benefited from new areas of strength, including television, automotive, and conventional lighting. Meanwhile, gross margins have been widening since the company has solved some of its production problems, which in the past had taken a toll on profitability. Earnings may improve significantly in 2009.

The company looks to take advantage of environment friendly facilities. Advances in brightness enable LEDs to rival other forms of light with much less power consumed. Cree has generated its first contracts to shift conventional lighting to LEDs. Recently, it was contracted to convert the downtown area of Ann Arbor, Michigan, which includes more than 1,000 street lights. Cree has similar contracts in other cities, as well.

The company made an acquisition recently to bolster its presence in lighting. Cree bought privately held LED Lighting Fixtures for $16 million in cash and 1.8 million shares. This deal is expected to help Cree in its new endeavors in energy-efficient municipal and facility lighting. The acqusition should aid the top line and lift margins soon through operating synergies and cross-sales.

Cree should continue to build its international presence. The recent acquisition of COTCO has been fully integrated, giving the company better distribution potential in Asia. This region will be important for building Cree's customer base, as many electronics manufacturers are located there.

For the March quarter, Cree reported revenue at the high end of adjusted guidance and in-line earnings. For the June quarter, revenue guidance was at the high end of expectations, but earnings guidance was below consensus. As such, the stock has fallen about 20% since the quarter was reported, to about 24 or 25. Some key take-aways from the March quarter were as follows:

1) Most analysts cut earnings estimates to reflect lower other income, higher litigation expense, and some dilution for the acquisition of LLF. One firm lowered their target price on Cree from 55 to 50.

2) XLamp revenue is still growing double-digit Q/Q, with the same expected for the June quarter.

3) There is still room for gross margin improvement given that LLF gross margins are well below the corporate average.

Moving on to the Oppenheimer Tech Conference, the company outlined their LED lighting strategy:

1) Drive revenue growth with LED components, which in turn they see to ultimately help drive demand for the overall market;

2) Leverage LLS fixtures and lamps to drive general lighting;

3) Leverage chip and materials business to enable growth product lines

The company sees the outlook with several trends:

1) LED lighting is real, but in early stages;

2) Momentum is building (confluence of tech readiness, market forces and government regulation;

3) Target significant growth over next several years as second generation LED system designs come to market

On the company's changing distribution, they say they have gone from a handful of customers, which they may have met with a couple times per quarter, to 1000's via agreements with Arrow and World Peace. The company sees less price pressure on their high power components but pressure on lower end units. The company reaffirmed 4th quarter targets (as of 4/22) of GAAP EPS of $0.04-0.06, which is not comparable versus the $0.09 First Call estimate. The company reaffirmed revenues of $129-133 million versus $131.06 million First Call estimate. They also stated mid-to-long-term financial targets of 40%+ gross margins and operating margins of 20%+.

Cree's long-term prospects are brightening. Cree has been rebounding from weakness in the handset sector thanks to better end-market diversification. Still, I remain somewhat concerned about stiff competition in LEDs, which could hurt pricing and market share for the company over the long haul.

The LED will be a strong theme in the next few years as the benefits of LED become mainstream in general illumination. I expect this market to grow at a CAGR of about 20% during the next 3 years. Cree is a leader in the LED space, with about 10% market share and a strong IP and product portfolio. Cree is one of the only ways for investors to participate in the LED market in the United States. Cree has communicated that it is a leader in LEDs, although besides the success of its XLamp product, the rest of the business is flat at best. The company is likely to see a further drop in its chip business for handsets, which is about 9% of sales.

Everyone has developed an opinion on the usefulness of LEDs since the development of white LEDs for general lighting. While the LED buzz at the LightFair overstated their adoption in the market, some of the applications could become game changers. It is encouraging to see about 150 LED vendors at LightFair and the interest of designers and engineers, but I would remain on the sidelines with CREE until they see a bigger uptick in display and outdoor fixtures, where Cree is better positioned than in backlighting.

Disclosure: None, but looking - Would consider buying if the stock price dropped another 15 to 20%, assuming the fundamental outlook described above did not significantly further deteriorate - In other words, if the stock simply dropped due to poor market conditions, etc.

1 comment:

Carlos K. said...

What are LLF's current gross margins?