Should Investors Avoid These Small LED Stocks?

May. 7.13 | About: Revolution Lighting (RVLT)

In this article I am going to look at the fundamentals of the leading LED stocks to see if they are indeed a sector of the market investors should be involved in. There has been much talk about the LED revolution lately, and with that talk there have been large increases in the stock prices of two companies. I will look at the story and numbers behind the big movers of this year to see if investing in them now is prudent.

First up we have Revolution Lighting Technologies, Inc (NASDAQ:RVLT). As of last week RVLT had a market cap of $280m. Revenues for the last year came in at $4.4m. The company is averaging a cash burn of approximately $7m per quarter over the last two quarters. If I give the company the benefit of the doubt and assume the $7.5m of investments they made last quarter was a one time event, the cash burn then drops to under $4m per quarter. In March RVLT raised $5m from the issuance of shares priced at $1.17. The company is still in need of additional financing, and with the stock price up 400% in the last three months, it would be wise for them to issue shares right now. This increases the risk for investors dramatically right now.

Another red flag I see is the shareholder letter that was issued. Two weeks ago the CEO of RVLT issued one of those "Shareholder Letters" where they outline their business objectives and cite outlandish market studies to show the future of their business. These letters are common for extremely low priced stocks that have low sales. In the letter RVLT mentioned the following, "Today LED lighting represents less than 15% of the available market. LED penetration by the year 2020 is expected to grow to 75% with a market total in excess of $100 billion. Revolution is in the right place at the right time." Whenever I read ridiculous market potential press releases like this I become very skeptical, especially when the company making these statements has posted total revenue of under $5m for the last YEAR. There may, indeed, be a huge surge in revenue for this company in the coming years but until there is some meaningful revenue and sales growth it is not a prudent investment now.

Next up I will look at SemiLEDs Corporation (NASDAQ:LEDS). This company is based in China, typically a red flag from the start. In the last year LEDS posted almost $26m in revenue with a net cash balance of approximately $36m. The market cap here is a small $42m, much cheaper than RVLT. LEDS has an average quarterly cash burn of about $5m, leaving them ample funding for the next two years at current spend rates. So far the financials here suggest that LEDS is undervalued, especially when compared to RVLT. Usually, however where there is smoke there is fire. In 2012 LEDS lost a patent infringement suit against CREE Inc (NASDAQ:CREE). The settlement prevents LEDS from selling it product in the US, a major red flag. This is also the likely reason for such a large drop in sales over the last year of almost 40%. Revenue for the second quarter of fiscal 2013 was $4.8 million, a 39% decrease compared to $7.9 million in the second quarter of fiscal 2012. It is disconcerting that a company in a sector that is supposedly experiencing record growth, is seeing its sales drop this much. A major red flag for investors. While the cash position is a positive, investors should note that this is a China based company. Accurate financials are not something Chinese companies are know for.

These two LED stocks have gained 400% and 300% in 2013. At the current time neither of these stocks can be viewed as investment candidates for long term investors. The risk in both of them far outweighs any potential return, especially given the large up moves both have experience this year. If sales and revenue begins to show growth in the coming quarters then perhaps it can be revisited. For now I believe these stocks are sells or avoids. If investors truly want to invest in LED stocks then the leader, CREE, is the place to look.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.