I like to strike while the iron is hot. That's why I've wasted
no time committing cash from my $100,000 real-money portfolio in
short order.
To recap...
I bought $12,500 worth of
Ford Motor (
F
)
, which
I think is poised for great things in 2012
, thanks to fresh car designs, a burgeoning cash balance and
rebounding demand for automobiles.
I committed a smaller stake to my second pick,
Alcoa (
AA
)
, just before the aluminum maker released year-end results and
issued an outlook for 2012. [
You can read my take here
.]
But sometimes, it pays to wait.
I wanted to parse Alcoa's results and confirm my opinion that
investors would begin to look forward to the company's brightening
prospects after digesting theearnings release. It looks like
they're doing just that, which is why I plan to buy an additional
700shares on Thursday, Jan. 12.
My third pick,
Zoltek (Nasdaq: ZOLT)
, is also off to a strong start, bringing readers a quick gain so
fast that it ran up roughly 10% before I was able to take my stake.
(Remember, I give you at least two days' notice before I make a buy
for my portfolio.) So I'm waiting to build my position on pullbacks
in the stock.
It's been a fun ride so far, and I expect a lot more excitement to
come. If you haven't already, I encourage you to sign up for these
portfolio ideas to be delivered to your inbox as soon as they're
published. [
Go here to sign up
.]
Now for my latest idea...
There's been a great deal of anger over an Obama administration
decision to phase out the use of incandescent light bulbs. Some see
it as a needless exercise in government intrusion into our lives,
limiting our choices. Yet these same people also want to see us cut
our dependence on foreign oil, especially from countries that we
would rather not have to cozy up to.
Though government-mandated changes can be annoying when it involves
items we have been using all of our lives, this policy change
should be a welcome one.
Why's that?
Because one of the best ways to cut out energy use is to get rid of
those incandescent bulbs, which date back to Thomas Edison's
heyday. The fact that these bulbs are too hot to touch when lit
tells you that much of their energy is being wasted in the form of
heat. In contrast, LED bulbs make so much sense. They're very
energy-efficient and can last years. The upfront cost, at roughly
five times the price, is a bit hard to swallow. But consumers see a
payback in terms of energy savings within just a few months.
Eliminating the need to frequently buy replacement bulbs only
heightens the Return on Investment (R.O.I.).
I have been focusing readers' attention on
Cree Research (Nasdaq: CREE)
, the undisputed leader in the global field of LED lighting. The
stock garnered a great deal of buzz as 2011 began, trading above
$65. Six months later, the stock had fallen by half, for reasons
I'll explain in a moment, and
I predicted better days ahead
as the company's long-term outlook remains really promising.
Well, investors continued to focus on an admittedly challenging
short-term picture, and in these uncertain times, they decided that
the long-term upside would have to wait.Shares now trade even
lower, 70% off their52-week high .
With such pessimism built in to this stock, I think acontrarian
take is essential.
The greatest headwind for Cree has been industry. Rivals flooded
themarket , leading to falling prices andprofit margins, and rising
inventories.
Take a look at Cree's numbers over the last four quarters.
Sales got off to a slow start last year, falling 15% sequentially
in the first quarter, and they've rebounded at a slower pace than
management expected. As a result, inventories surged, which led to
price cuts that crushed margins. The problem is still being
resolved. At the end of the most recent quarter, Cree had more than
100 days' worth ofinventory on hand, which is far too much for a
just-in-time business.
In my view, the future direction of this stock will hinge on how
these numbers trend.
More recent signs are promising. For example, based on current
sales run rates, gross margins should flatten in the quarter that
just ended and rise roughly 0.5% during each of the next two
quarters. That's not due to an expected firming in pricing but
rather a lowered cost of manufacturing. Equally important, output
has been throttled back. And thoughinventory may not drop sharply
in the December 2011 quarter, it should steadily trend down in
coming quarters, thanks to rising demand and flat production.
The reversal of these metrics are a key reason to focus on this
stock now.
Perhaps the most promising data point is that China, which accounts
for 40% of Cree's revenue, apparently embarked on a year-end budget
flush, placing fairly large orders for LED lights in December. That
removes a key risk for this stock, as December quarter results are
now likely to meet or exceed current forecasts. (Cree has slightly
trailed forecasts in three of the last four quarters.)
With an eye toward capital preservation, I didn't want to own this
stock on the cusp ofearnings season if I thought a subpar quarter
was imminent. Cree will release fiscal second-quarter results on
Tuesday, Jan.17.
Make no mistake, this will always be an industry marked by price
declines, as risingvolume sparks greater competition. One industry
study, conducted by analysts at Needham, predicts demand for LED
lights will grow 90% a year for the next five years. But industry
sales will only rise 38% annually as price cuts take a bite out of
revenue.
The question for us is how much of that growth is captured by Cree?
And what kind ofprofit margins can the company garner?
On the first question, Cree should surely benefit from an expanding
pie. Analysts expect the company to boost sales roughly 25% in each
of the next two fiscal years, culminating in a sales base of $1.55
billion by fiscal (June) 2013. I think 20% growth would be a
prudent expectation, just because the company hasn't lived up
recent expectations (though it surely did for a number of years
before 2011).
And though management has laid out plans to get gross margins back
above 40% by boosting manufacturing yields and entering niches with
firmer pricing, I think it's better to assume this never happens
and that gross margins remain stuck below 40%. (They had been above
40% in six of the last eight years.)
I may be toobearish here. Cree is working on a raft of technology
tweaks that will extend its lead against many other LED lighting
makers. That's the payoff of an R&D effort that by some
estimates has been as large as the rest of the industry --
combined.
Bearish or not, I expect results to be good -- not great -- in
coming quarters. Yet I think this is stock is vastly oversold.
To be sure, Cree isn't a stock to own for near-term results. It may
look quite cheap at just 12 times consensus fiscal (June) 2013
forecasts of around $1.80 a share. But I want to take a much more
cautious stance, anticipating per share profits of just $1.50. That
puts the forward multiple at around 14. Still, not bad...
The downside protection -->
This company was valued at $8 billion a year ago and is now valued
at just $2.5 billion. Back out the company's $600 million in net
cash, and theenterprise value slips under $2 billion, roughly half
of what the sales base may look like by 2014 or 2015.
The upside triggers -->
As noted above, a reversal of deteriorating quarterly trends on
theincome statement andbalance sheet is the most solidcatalyst .
Once that happens, investors can again focus on the bright
long-term view. Note that sales came in under $500 million in
fiscal (June) 2008, almost hit $1 billion in fiscal 2011, and could
approach $2 billion by the middle of the decade.
Assuming gross margins in the low 30s,earnings could hit $4 a share
by then. That's the way this stock was once viewed back in early
2011 when it hit almost $70, and that's the way it should again be
viewed. It may take some time for sentiment to reverse, but the
powerful macro trends underpinning demand for LED lighting will
eventually determine this stock's fate. At a recent $21, the upside
looks too good to pass up.
Action to Take -->
As a solid core holding, I am allotting 300
shares
(or roughly $7,000) to this stock. I'll make the trade on Thursday,
January 12 and will adjust the position after glimpsing at the next
quarter'sgross margin and
inventory
figures.
Here's the Latest Snapshot of my $100,000 Real-Money
Portfolio...
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-- David Sterman
P.S. -- Remember, you're invited to trade right along with me.
I'll even give you at least a two day head start. Don't miss a
thing and sign up to receive my latest ideas for free.
David Sterman does not hold positions in any securities
mentioned in this article. StreetAuthority owns shares of F, AA in
one or more if its "real money" portfolios.