Investors are often faced with a clear conundrum -- what to do
with a stock that holds great long-term promise and stumbling
near-term execution. That question has been vexing me ever since
Cree Inc. (Nasdaq: CREE)
$100,000 Real-Money Portfolio
in early January and then
make a quick upward move.
At the time, I wrote that gross margins were unlikely to post a
near-term rebound after slipping from the low 40s to the mid 30s.
And I added that investors were concerned that results wouldn't
improve until bloated inventories were worked down. My conclusion:
"The future direction of this stock will hinge on how these numbers
trend." Yet I also thought the stock had tangible downside
protection trading in the low $20s.
I was wrong. Investors embraced this stock much more quickly than I
expected, turning Cree into the strongest gainer in my portfolio.
Kudos to the crowd for spotting the great long-term opportunities
in front of this LED lighting supplier.
Just a few weeks later, investors again showed a newfound
farsightedness, overlooking another challenging quarter, which
I discussed here
Well, this time around, investors aren't in such a forgiving mood.
Shares of Cree slipped back below $30 inafter hours trading on
Tuesday, April 17, after the company delivered a subpar fiscal
third quarter. The key culprits: you guessed it -- weak gross
margins (34.9%) and a bloatedinventory (worth 96 days of sales).
Adding further pain, guidance for the fiscal fourth quarter is also
uninspiring: The midpoint of the targeted sales range is $305
million, below the $324 million consensus. Non-GAAPearnings per
) are expected to be around $0.23, below the $0.28 consensus.
The bright side
This is still very much a growth story. Even that lowered sales
guidance represents a company record and 30% growth from a year
ago. Management has recently laid out key technology developments
that should at least keep gross margins at current levels. Cree
operates in an industry that is rapidly commoditizing, but the
company's massive research and development effort should help keep
it above the fray. Gross margins in the 35% range are disappointing
in light of the company's history, but are still the most
impressive in the industry -- by far.
Make no mistake. This stock is no longer being valued on the basis
of current quarterly run rates. The post-earnings sell-off would
have been far more dramatic if investors were viewing this stock in
terms of near-term profits. Indeed, you can look for analysts to
lower their fiscal 2013EPS forecast, which currently stands at
$1.50 (perhaps, as a rough guess, to around $1.25 a share).
Strangely enough, this is still one of the biggest potential
winners in my portfolio -- despite the near-term doldrums. The
broader investment community still underestimates just how powerful
the LED lighting revolution will be. I have no doubt that Cree will
see intense competition and will losemarket share . But the pie
will be so big that even a smaller slice of that pie will still be
What I wrote in January still stands: Cree's revenue could approach
$3 billion to $4 billion by mid-decade (from a current projection
of $1.47 billion in thefiscal year that begins in July). AndEPS in
the $3 or $4 range by then is a real possibility -- if pricing and
gross margins don't deteriorate further.
[block:block=16]Despite the modest sell-off in shares on
Tuesday, analysts hold an increasingly positive view. Jefferies,
for example, raised its
from $31 to $35, adding that the upcoming Lightfair industry
conference, to be held on May 9, could be a positive
for the stock. Oppenheimer's price target was boosted from $34 to
$38, noting that the company's recent challenges are now "in the
rear-view mirror." Keybank lowered its price target from $37 to
$35, noting the company's "recovery appears to be more muted than
previously expected." As I've noted, I see a lot more upside
than these price targets by looking at several years and not
several quarters, as these analysts tend to do.
Action to Take -->
That said, I'm simply standing tight right now and neither adding
to or selling my current 300-share position. Clearly, I should have
taken a bigger stake in January, but I didn't anticipate a quick
upward move that we saw in the stock later in January. At this
point, I'm tempted to wait for a deeper pullback, though if you
don't yet own this high-growth company, this week's sell-off may
create a fresh entry point for you.
My recent gain in Cree is just the beginning. To find out more
about my recent winners, and to get instant access to my analysis,
go here to sign up
-- it's free for a limited time.]
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of CREE in one or more if its "real money" portfolios.