As we head intoearnings season , this
$100,000 Real-Money Portfolio
holding, also one of my first picks, is due for an update. The
stock has already risen by 19% since I bought it in January, and
could have a lot more upside -- if a key investment metric stands
I'm taking about LED-lighting manufacturer
Cree Inc. (Nasdaq:
, which I first profiled
. Back then, I wrote that "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.)
It's simply the nature of this company's growth
As Cree pursues more customers, it must compete with an
expanding pool of competitors, many of whichoffer inferior
technology and therefore price their products very aggressively.
For Cree, the goal is to figure out just how much it can charge
-- to reflect the higher quality of its products -- before it
starts losing orders to rivals. And lost orders are deadly for a
stock like this. After all, Cree has boosted sales at least 14%
each of the past five years, and analysts are expecting sales to
rise at least that much in fiscal (June) 2013 and again in fiscal
Yet even as Cree works to meet top-line forecasts, many
investors want to see that the company isn't getting too aggressive
on pricing, sacrificing gross margins for the sake of the top line.
Well, how has Cree fared on that count? Let's look at Cree's gross
margins since the prior three quarters before I bought this
Gross margins fell in the company's fiscal second quarter of
2012 to just 34.6%. Yet in the past two quarters, they appear to
have firmed up slightly. And that's crucial. As long as gross
margins are no longer sliding lower, investors will have reason to
trust that management isn't pursuing growth in an unsustainable
manner. Instead, management is striking a balance between sales
growth and bottom-line results.
Cree's management understands the need to deliver solid
bottom-line results, but the company is still making heavy
investments in its infrastructure to handle projected growth in the
years to come. For example, Cree spent $143 million on research and
development (R&D) efforts in fiscal 2012, and it isn't stepping
off the gas now.
As a result, analysts have had to tamp down theirprofit
forecasts to account for high levels of spending. Roughly three
months ago, analysts expected Cree to earn around $1.35 a share in
fiscal (June) 2013 and around $1.90 a share in fiscal 2014. These
forecasts have been trimmed by 10 cents and 20 cents, respectively,
during the past three months.
Make no mistake, the next few quarters are crucial for this
stock. That's because analysts say Cree's rising sales base --
coupled with stabilized gross margins -- should finally
enableearnings per share to start growing at a solid pace. Take a
look at Cree's recent earnings per share performance and
expectations for the next few quarters.
Cree is expected to announce 2013 fiscal first-quarter results
in mid-October. Analysts are currently looking for earnings of 26
cents per share, a 4% increase from the year-ago quarter. More
important will be what management has to say about the rest of
thefiscal year . Will Cree be on a path for ever-rising earnings
per share, as the chart above indicates?
A quick view of Cree's stock chart implies that investors
anticipate solid quarterly reports to come. Although the long-term
"story" around LED lighting is impressive, Cree is no longer so
beaten down that it can afford to deliver sub-par quarters in the
Risks to Consider:
Though Cree has excellent long-term positioning, investors need
to brace for any near-term hiccups in this high-growthbusiness
model .Shares were hit by profit-taking this summer on just such
concerns, before a recent rebound, so investors need to brace for a
possible repeat performance.
Action to Take -->
If you have a long-term focus, then much of this is noise -- unless
Cree's gross margins weaken anew. If you see margins weakening,
then it may be wise to lock in profits in this stock, as it will be
a sure sign that thecommoditization of LED lighting will blunt any
secular sales growth Cree may experience.
Yet as along as margins remain stable, this still has the
makings of a top-performing stock into mid-decade, by which time
adoption of LED lighting should be extremely robust. There are a
number of players in the space, but Cree appears to be the
technology leader by a considerablemargin . How the company parlays
its massive levels of R&D into leading-edge product lines will
ultimately determine how high this stock can go. Recall that this
was a $70 stock less than two years ago. I think it will be quite
some time before we ever see that mark again, but if you've got a
multi-year time-frame, then this is an upside opportunity to be
The near-term wildcard for Cree is China. The Chinese government
is looking to keep rolling out LED lighting, recently awarding
contracts to three local suppliers that will be using Cree's
technology. That's likely to be the dominant topic of the upcoming
conferencecall . And it's likely to keep this stock in the mid to
upper $20s or perhaps bump it into the low $30s during the next
three to six months.
-- 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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