Investing in an undervalued high-growth play brings an inherent
challenge.Shares are usually undervalued because the near-term
growth prospects aren't as bright as the long-term prospects. This
was the biggest risk factor
I laid out
when I added
Cree Inc. (Nasdaq: CREE)
$100,000 Real-Money Portfolio
"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," I noted when
I recommended this stock last month. In fact, subsequent tepid
quarterly results led analysts to lower their view, so the
consensus fiscal 2013profit forecast now stands at $1.47 a share.
Nevertheless,shares have staged an impressive rally and are now up
more than 30% in the past two months.
[block:block=16]This creates a real conundrum, because I still
think quarterly conditions remain challenging. Indeed, analysts at
Credit Agricole downgraded
to "underperform " on Monday, Feb. 13, lowering theirprice target
from $30 to $26 and pushing the stock down by roughly a dollar to
$27 per share in an otherwise risingmarket . The firm's analysts
say the recent rally may be overdone in relation to
still-challenging industry conditions as prices for LED lighting
continue to fall. My concern: shares can slip back into the lower
$20s when Cree releases fiscal third-quarter results in mid-April.
I want investors to be prepared for this possibility so they can
preserve profits if they so choose. Yet for those who look at this
as a one or two-year holding, this is really just noise. Sure,
shares may consolidate in coming weeks, but they have considerable
upside in the quarters ahead.
I retain this view after digesting events at the just-completed
Strategies in Light 2012 conference held in Santa Clara, Calif.,
last week. (There are four of these conferences held around the
world each year: the next one takes place in May in Shenzen, China,
and is the industry's most important annual event, thanks to
China's huge investments in LED lighting).
Perusing the various reports of analysts who attended the
conference, some clear themes have emerged. The LED-lighting
industry is undergoing a shakeout ascommodity LED-chip providers
struggle with the deepest price cuts, while makers of advanced
LED-lighting designs such as Cree are attracting better order flow
and (relatively) firmer margins.
This means Cree should soon start to post more stable results as
pricing for its products decline at a much lower pace. Industry
conditions remain challenging due to industry overcapacity.
(Factory utilization rates hover in the 45% area, and would need to
move toward 60% before pricing pressures truly abate). Analysts
seem to understand the current dynamics: The consensus forecast for
Cree's fiscal third-quarterearnings per share (
) was recently lowered from $0.30 to $0.21. Did the analysts go far
enough? I don't know, but upside to that lowered forecast is
Taking the longer view, Cree's sales and profits should mark steady
gains in 2013 and beyond, as I laid out in my initial focus on this
stock. But for the rest of 2012... well, two potential catalysts
lay on the horizon.
First, Cree is increasingly the subject ofbuyout rumors. I hate
that. These rumors rarely come to pass, and as it becomes apparent
that no suitor is waiting in the wings, shares could give up recent
gains when themerger andacquisition (M&A) traders step away.
Second, the China Solid State Lighting Alliance (
) is expected to issue updated spending plans later this year.
China has wisely understood the long-term payback associated with
LED lighting in terms of longevity and low power consumption, and
has been spending heavily on the technology in recent years. It's
crucial that China remains supportive with its future plans and
that Cree continues to play a key role in the Chinesemarket . What
the CSA has to say is the biggest risk and opportunity for Cree in
2012. Unfortunately, the timing of any moves is unclear.
Risks to Consider:
Cree remains a great investment but is not as appealing as a
trade. Indeed, the downside support I noted last month is no longer
in place. I was convinced this stock always had ready support from
new buyers when it was hovering near $20, but that isn't the case
with the stock in the high $20s.
Action to Take -->
I encourage you to take the long view. If my concerns come to pass
and Cree's shares see further profit-taking, then far-sighted
investors should see those windows as entry points. I committed
roughly $7,000 on this pick a month ago, and would be glad to add
to the position in the face of fresh share-price weakness.
Remember, my $
investments are being made available for free for a limited time
only. Be sure to take advantage of this limited-timeoffer by having
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-- 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.
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