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I'm Expecting Big Things from This Portfolio Holding

By: David Sterman
Posted: 1/18/2012 1:00:00 PM
Referenced Stocks: AA;CREE;F;ZOLT

The stockmarket is surely unpredictable. My prediction that LED lighting manufacturer Cree Inc. (Nasdaq: CREE) , one of the stocks in my $100,000 real-money portfolio, would meet or exceed fiscal second-quarter estimates, turned out to be off the mark. The company trailed both top andbottom line forecasts, and issued fairly tepid third-quarter guidance to boot. Still,shares are up more than 4% in today's trading as investors are (correctly) focusing on the bright long-term view.

An update on my $100,000 Real-Money Portfolio holdings...
Now that two of my $100,000 real-money portfolio holdings, Alcoa ( AA ) and Cree, have both reported, I look forward to hear what Zoltek (Nasdaq: ZOLT) has to say when the company releases fourth-quarter results in mid-February. Third-quarter results were strong, but this company delivers an erratic set of results, so my long-term bullishness is in tandem with the possibility that fourth-quarter results may just be OK.

As you may remember, I recommended shares of Zoltek on Jan. 5 at about $7.70 a share. If you bought when I recommended the stock, you're already sitting on a nice gain. But since I give readers two days' notice before making a purchase, the stock has since gotten away from me, so I'm currently awaiting a better entry point

[Don't miss a thing -- sign up here to receive the latest updates and additions to David Sterman's $100,000 Portfolio completely free.]

On the other hand, I'm expecting a solidquarterly report from Ford ( F ) when fourth-quarter results are delivered in late January. That's because the auto maker posted solid sales results in November and December in the United States, more than offsetting the weakness seen in Europe. The consensusEPS forecast remains stuck at $0.26, despite a recent stream of good news. Don't be surprised to see Ford earn $0.30 or even $0.35 a share this coming quarter.

However, Ford could decide to establish a conservativeprofit target for 2012, soshares won't necessarily rally when results are released. Still, I love the long-term positioning of this company and am not holding for short-term gains.

Now, let's dig a little deeper into those Cree results...
Cree's fiscal second-quarter lagged expectations. Sales of $304 million, though up 13% sequentially, were lower than the consensus estimate by $5 million, andearnings of $0.25 per share were a penny shy of forecasts. But management cautioned investors that the current quarter won't represent a big sequential jump as the last quarter had. As a result, third quarter guidance was softer than I expected, and sales are likely to be flat with the second-quarter (though still up more than 30% from a year ago). Yet persistent pricing pressures will keep a lid on profits. Cree expects to earn around $0.18 to $0.25 a share, below the $0.27EPS earned in March 2011 and the $0.29 a share analysts had been expecting.

When I recommended this stock, I cited a pair of important drivers: stable gross margins and falling inventories. The results are mixed on that score. Gross margins fell to 35.3%, from around 36% in the fiscal first quarter. Had they been in line with the prior quarter, Cree would have exceededprofit forecasts by a few pennies. Management is still targeting a rebound to 40% gross margins six to 12 months from now, a level seen in the recent past, but I am dubious of that forecast.

Part of thegross margin weakness stems from the fact that Cree has too much capacity. Its factories are working at just 60% of their potential output. So management has announced plans to sharply slow new capacity additions and let demand catch up. That may be why management expects to eventually see a solid rebound in gross margins.

On the plus side, inventories fell by $16 million sequentially and now represent a more reasonable 85 days of sales outstanding (from 92 days in the September quarter). I'd still like to see that number move closer to 70, but the trend is promising.

The tepid quarterly results shouldn't alarm. After all, this stock has plunged from around $70 a year ago to the low $20s, so expectations remain quite low. To put the dim outlook in context, I repeat what I wrote back on Jan.10 in my initial analysis of Cree : "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 expect the consensus forecast to come down to my forecast in coming weeks, though this stock remains inexpensive, even against that lower view.

Action to Take --> My investment thesis remains intact. Cree's results should strengthen later this year as LED adoption builds. My hopes that it would happen as soon as the current quarter have been dashed, but I remain steadfast in my view that this former highflyer will see better days ahead.

Stay tuned... I'll be delivering another investment idea and adding it to my portfolio later this week. 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

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of CREE, F, AA in one or more if its "real money" portfolios.