Many consumers are still ignoring the quickest way to lower
their utility bills.
Swapping out all of your older light bulbs for new
light-emitting diode (LED) bulbs can save hundreds of dollars in
power costs. And the fact that these bulbs can last up to 25,000
hours means you're all set for the next decade.
This new technology has been a notable success story for
Home Depot (
, and its key LED supplier,
Cree (Nasdaq: CREE)
. You would think that
would also like to have been a major vendor of this cutting-edge,
cost-saving lighting technology. But the LEDs it sold from many
manufacturers have always been a bit too pricey for Wal-Mart's
Yet a little-noticed announcement from
Wal-Mart's new Great Value LED lights, made by GE, are priced
under $10, which is crucial in two respects. It's a price point
that lures many more consumers to make the change, considering
these bulbs can now pay for themselves in terms of power
consumption in just two or three years. And it's a nightmare
price point for Cree, which appears hard-pressed to make profits
at such a price.
At least that's the view of Piper Jaffray's Jagadish Iyer: "At
a $10 price point, we see a big squeeze on profitability at least
initially for the OEMs, as we have highlighted in the case of
Cree, where we think its light bulbs currently carry negative
For a bit of context, Wal-Mart is selling GE's dimmable
60-Watt LED bulb for just under $11 -- roughly $2 less than
Cree's price at Home Depot.
A Long Climb Back
Make no mistake, Cree deserves a huge amount of credit for
stimulating demand in the LED market, which had been slow to take
off in 2010 and 2011. The company pushed hard to hammer down its
own costs, getting many of its bulbs below the $20 price point in
recent years. That's why I thought this stock was so
appealingback when it traded for $20 in early 2012.
Yet as Cree's shares have now rebounded sharply, investors may
be ignoring the serious challenges ahead for the company. Simply
put, industry production capacity is growing at a rapid pace,
which will surely impact pricing and gross margins.
|© 2013 Cree, Inc.
Cree pushed hard to hammer down its own costs,
getting many of its bulbs below the $20 price point in
Across the globe, companies such as China's Yankon, Elec-Tech
International, and San'an, Taiwan's Epistar, and South Korea's
LG-Innotek and Seoul Semiconductor are ramping up production of
"good enough" products that may not be quite as leading edge as
Cree's LED products, but good enough to be long-lasting and meet
low price points.
In effect, LED lighting is about to be hit by the "Wal-Mart
effect," where price trumps all, leading industry margins to
Gross Margins At A Peak?
Cree's fiscal fourth-quarter results (for the quarter ended June)
were just shy of forecasts, and tepid fiscal 2014 guidance has
led the EPS consensus to drop from $1.87 to $1.77 over the past
60 days. D.A. Davidson's Avinash Kant used the quarterly results
as the basis for a ratings downgrade to "neutral" (lowering his
price target to $65), noting concerns that slower than expected
margin expansion and revenue growth leaves very little room for
upward earnings revisions.
Analysts have been continually forecasting margin gains as
Cree more fully utilizes its manufacturing capacity, but so far,
that's just not happening.
Cree has been able to make major gains in terms of its
manufacturing efficiency and overhead absorption, but
ever-tougher industry pricing pressures keep the company from
benefiting from lower costs.
Will margins ever rebound?
Despite those apparent challenges, many of which reappeared on
the fourth-quarter conference call in early August when shares
slumped below $60, they've rebounded once again to near the
52-week high of $76 as investors again focus on the positive
traits of the LED lighting industry.
But at current prices, these shares are no bargain, trading
for nearly 35 times projected fiscal 2015 profits. Yet it's fair
to wonder if the rapid fresh price declines for LED light bulbs
(led by Wal-Mart and GE) will make it impossible for Cree to
deliver the margin growth that the most bullish investors are
Risks to Consider:
As an upside risk, Cree has long been seen as a buyout
candidate, and some of the recent share price strength is
attributable to buyout rumors.
Action To Take -->
When shares of Cree were widely reviled in early 2012, shares
traded for little more than 10 times forward earnings. Less than
two years later, investors are now according a much richer
multiple to this stock. As a result, Cree now faces a much higher
hurdle. Investors may be in for a rude surprise if the company's
profit margins remain stuck in neutral in coming quarters.