If you want to be a thorough investor, then it's absolutely
crucial to keep track of once-lovedgrowth stocks that have fallen
out of favor. Many investors simply move on to other ideas, not
fully understanding that lagging growth stocks may simply be
suffering from some short-term growing pains. When the company's
growth trajectory comes back into focus,shares can subsequently
post remarkablegains .
That was the case with LED maker
Cree Research Inc. (Nasdaq:
in January 2012, when shares were on a downward spiral, falling
from about $80 to just $23 in just a few years.
As a bit of background, during his first term, President Barack
Obama announced efforts to phase out the use of incandescent light
bulbs to reduce energy use and costs.
Needless to say, Cree and its energy-conscious LED lights
quickly became a hot growth story.
But the "story" of thisstock remained just in theory.
Investors started to grow frustrated that the LED-lighting
industry was slow to develop. After all, sales growth decelerated
from 53% in fiscal (June) 2010 to just 14% in fiscal 2011. Some
investors mistakenly assumed thismarket had already matured, even
though we're only in the early innings of industry growth.
This view has now come back into force, as shares have been
soaring in recent weeks.
I've written about Cree on several occasions in the past, but
the recent gains for Cree are a result of a game-changing
announcement. Whereas LED lights had previously been too expensive
for mass market adoption, priced in the $20 to $30 range, Cree has
plans to sell a new a line of LED 40-watt lights at retailers such
Home Depot (NYSE:
for just $10. That's still alot more expensive than traditional
incandescent bulbs, but considering that LED lights use 80% less
energy, the payback time in terms of saved energy is just a few
years. And these light bulbs can last for more than 10 years, which
coincidentally, is how long their warrantywill last.
Cree paired this announcement with a bump in quarterlyguidance
as well. Sales for the 2013 fiscal third quarter ending this month
will likely be about $342 million (using the mid-range of
guidance), which is 2% above the consensus forecasts and roughly
20% higher than year-ago levels. Management also bumped up
theearnings outlook, from a range of 30-35 cents a share to 31-36
cents a share.
This is a nice shift from recentquarters , when Cree had a habit
of lowering guidance as the LED market faced myriad pricing
pressures and order deferrals. Yet, even as Cree starts to fulfill
its promise, a keyissue remains in place: LED lights, as
highlighted by the $10 bulb, may not be very profitable.
Indeed, even with higher-priced LEDs, Cree's gross margins have
been under severe pressure in the past few years and have rebounded
only modestly in recent quarters.
Gross margins will likely never move meaningfully above 40%
simply because the LED industry will be characterized by
ever-fiercer pricing pressures. Cree's $10 LED light bulb is great
news for unit sales growth, but it's simply unclear whether the
company will be able to generate decentprofit margins at that
To itscredit , Cree's heavy research and developmentinvestments
have enabled it to steadily lower manufacturing costs. But rivals
will likely catch up, eventually. Competition from established
lighting firms such as
is growing (though they are also partners as they use some of
Cree's technology), but a number of Chinese manufacturers are also
ramping up production. These manufacturers have thus far been
unable to match the power output or long-term durability of Cree's
LEDs, but it's unwise to think they won't catch up over time.
One of the keyfactors behind this stock's huge drop in 2011 was the
realization that Cree may never deliver the robustcash flow to
justify a market valuation that at one point, exceeded $9 billion.
Themarket value has now stands at a more reasonable $6 billion, but
still looks pretty rich in the context of projected cash flow.
D.A. Davidson pegs fiscal (June) 2014 cash flow at about $180
million, meaning that the company is trading at more than 30 times
that figure. Looking another year out, to fiscal 2015, UBS sees
that figure hitting $250 million, though by that time, this
industry's strong growth trajectory may have started to cool. The
$6 billion market value more than accounts for the cash flow growth
Risks to Consider:
As anupside risk, Cree has long been rumored to be abuyout
candidate, though the recent spike in market value may soon make
this too big a fish to digest.
Action to Take -->
As I've written about Cree on several occasions in the past, this
is an excellent stock, but one that's subject to bi-polar
perspectives from investors. A few solid quarters, and investors
bid up shares strongly. Conversely, a few weaker quarters, and this
stock tends to fall out of bed. It's unwise to chase this stock at
this point, and if history is any guide, then a quarterly stumble
later this year couldput shares right back into value
-- 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 of its "real money" portfolios.