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Cree Not Burning Out Yet
Judging by the early reaction in the market, LED specialist Cree (Nasdaq:CREE) is going to take a hit in the wake of its fiscal fourth-quarter earnings and forward guidance. At first blush this may look like a case of Wall Street saying that nothing is ever good enough, but a quick glance at the valuation reveals a more typical growth stock profile. This, then, is the tradeoff for investors - the ride up from below $15 in late 2008 to the recent high near $80 was a blast, but with that moves comes extremely aggressive expectations and hair triggers on the sell orders at the first hint of trouble.
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The Quarter That Was
Simply put, there just are not very many companies growing like Cree right now. Revenue jumped 79% this quarter to $265 million, with XLamp LED components once again proving to be a strong driver. Impressive as that growth is, it was basically spot-on for what analysts had forecast for the company. Once again, this is a company that is doing great, but where the expectations are so high that a lot of institutional investors are going to turn around and ask "what else ya got?"
Cree paired strong top line performance with solid profitability. Gross margins jumped nearly 10% (to 49.5%), while operating margin more than tripled to nearly 26%. These improvements in profitability were a bit ahead of expectation, and the company did beat its EPS hurdle number.
The Road Ahead
Guidance is the boogeyman for most growth stocks, and Cree is no exception. Management put out a revenue range for the September quarter with a midpoint about $10 million below the prior analyst average - roughly a 4% shortfall, but one that cost upwards of $800 million in lost market capitalization at the open.
For those who can look past the quarter-to-quarter guidance game, there is a lot to like about Cree. There is fierce competition throughout Cree's businesses, but Cree still seems to have a leg up on the likes of Siemens (NYSE:SI), Philips, (NYSE:PHG) or Vishay (NYSE:VSH) in the components business.
Perhaps it is technological details like Cree's use of silicon carbide instead of sapphire, or other engineering and performance specifics that give Cree its edge, but it is clear from the revenue and margin performance that Cree is doing something different than its competitors.
Still, competition is the number one worry about this name. There is no question that the LED market is poised for years of growth, as these components move from Apple (Nasdaq:AAPL) iPhones and Motorola (NYSE:MOT) Droids, into Samsung LCD TVs, and then into general lighting applications that you can buy at your local Home Depot.
A lot of that growth is going to get absorbed by a small horde of Korean and Taiwanese companies such as AU Optronics (NYSE:AUO), which is looking to get bigger in the LED market. This cannot be good for pricing. Still, it does appear that Cree has a better mousetrap when it comes to its manufacturing process, and perhaps Cree will be one of the few companies that can prosper in a lower-price environment.
The Bottom Line
Cree's decision to reorient from a dependence on chips into higher-value components and fixtures looks like a good one. It's also nice to hear that demand for LEDs is so strong that it has caused periodic shortages in applications like LCD TV backlighting, and that capacity is a limiting factor for revenue growth.
What I do not like so much is the valuation and the expectations that go with it. Risk (or, more accurately, volatility) tolerant investors can seriously consider this stock as a long-term option for the portfolio, so long as they can live with days like Wednesday. But nobody should go into this stock thinking that it is anything like "cheap". Expect Cree to continue to grow very well over the next five-plus years, and if the post-earnings pullback leads into a longer decline, give some thought to putting this one into the aggressive growth corner of my portfolio. (For more, see The Value Investor's Handbook.)
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IN PICTURES: 20 Tools For Building Up Your Portfolio
The Quarter That Was
Simply put, there just are not very many companies growing like Cree right now. Revenue jumped 79% this quarter to $265 million, with XLamp LED components once again proving to be a strong driver. Impressive as that growth is, it was basically spot-on for what analysts had forecast for the company. Once again, this is a company that is doing great, but where the expectations are so high that a lot of institutional investors are going to turn around and ask "what else ya got?"
Cree paired strong top line performance with solid profitability. Gross margins jumped nearly 10% (to 49.5%), while operating margin more than tripled to nearly 26%. These improvements in profitability were a bit ahead of expectation, and the company did beat its EPS hurdle number.
The Road Ahead
Guidance is the boogeyman for most growth stocks, and Cree is no exception. Management put out a revenue range for the September quarter with a midpoint about $10 million below the prior analyst average - roughly a 4% shortfall, but one that cost upwards of $800 million in lost market capitalization at the open.
For those who can look past the quarter-to-quarter guidance game, there is a lot to like about Cree. There is fierce competition throughout Cree's businesses, but Cree still seems to have a leg up on the likes of Siemens (NYSE:SI), Philips, (NYSE:PHG) or Vishay (NYSE:VSH) in the components business.
Still, competition is the number one worry about this name. There is no question that the LED market is poised for years of growth, as these components move from Apple (Nasdaq:AAPL) iPhones and Motorola (NYSE:MOT) Droids, into Samsung LCD TVs, and then into general lighting applications that you can buy at your local Home Depot.
A lot of that growth is going to get absorbed by a small horde of Korean and Taiwanese companies such as AU Optronics (NYSE:AUO), which is looking to get bigger in the LED market. This cannot be good for pricing. Still, it does appear that Cree has a better mousetrap when it comes to its manufacturing process, and perhaps Cree will be one of the few companies that can prosper in a lower-price environment.
The Bottom Line
Cree's decision to reorient from a dependence on chips into higher-value components and fixtures looks like a good one. It's also nice to hear that demand for LEDs is so strong that it has caused periodic shortages in applications like LCD TV backlighting, and that capacity is a limiting factor for revenue growth.
What I do not like so much is the valuation and the expectations that go with it. Risk (or, more accurately, volatility) tolerant investors can seriously consider this stock as a long-term option for the portfolio, so long as they can live with days like Wednesday. But nobody should go into this stock thinking that it is anything like "cheap". Expect Cree to continue to grow very well over the next five-plus years, and if the post-earnings pullback leads into a longer decline, give some thought to putting this one into the aggressive growth corner of my portfolio. (For more, see The Value Investor's Handbook.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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