Cree: 2 Chances Are More Than Enough

Oct.23.13 | About: Cree, Inc. (CREE)

A stock's valuation is nothing more than a balance between fundamental performance and expectations. If a company consistently beats expectations or has high expectations then its valuation is likely to be a premium on earnings. In the case of Cree (NASDAQ: CREE), the market had high expectations for its LED light bulbs, as consumers become more energy efficient coupled with a boom in housing. However, after two strikes, is it now time to give up on Cree?

Cree lowers guidance... Again!

First, let's look at the obvious: Cree is trading lower by 17% after announcing first fiscal quarter earnings. The company's performance was actually decent as it met expectations with revenue growth of 24% year-over-year. However, what investors didn't like was revenue, earnings, and margin guidance, thus causing the stock to falter.

Admittedly, Cree's fundamental performance would be considered a positive by most measures. But in this particular case, Cree has rallied 100% in the last year - despite its intraday loss - and trades at 80 times earnings. Hence, it is not a cheap stock, and to make matters worse, investors have been through this before.

Back in its fiscal fourth quarter, the company reported a similar report. It met expectations but lowered guidance for this newly released quarter. Thus the company's "met" guidance on Tuesday was actually on lowered guidance that had already caused the stock to decline 15% back in August. Even then, in August, sales were slightly below estimates and guidance was far below the consensus. Cree has not lived up to high expectations.

Pricing & competition remain a threat

Strangely, after Cree's bombed fiscal fourth quarter report in August, Cree recovered all of its losses and returned back to 52-week highs. Yet, this earnings report now marks the second in a row that guidance has been lowered, and at some point there has to come a time where investors realize that Cree is not going to be the company that they expected.

The primary reason comes down to pricing. Yes, LED lights are the "in" item and save on electricity in long term. But if you're a consumer, the choice remains whether or not you'd rather pay $75 now (for six bulbs) to have brighter lighting and savings of nearly $7 a year (based on three hours per day). Over the 22 years of the bulb's life, the savings would pay for the cost. However, the dilemma has always been whether or not consumers saw this long-term savings as economical versus the six pack of regular bulbs for $3-$5.

With that said, consumers simply don't appear to be choosing Cree's LED light bulbs over traditionally lower cost bulbs at the rate that many investors anticipated. Moreover, Cree is now facing the retail juggernaut that is Wal-Mart (NYSE:WMT), and its six-pack of LED bulbs for less than $9.00. Granted, Cree likes to defend its product and its premium pricing by saying that it's focusing on "quality". However, according to the item description on both products, Wal-Mart's Great Value LED lights save up to 80% on energy costs; Cree's bulbs use 84% less energy, with Cree's 84% in savings translating into just $7 per year, it is clear that Wal-Mart with a 4% differential in energy benefit and a $65 difference in price is the "best value". Most likely, consumers are able to do the same math, leaving many to wonder if Cree will eventually be forced to lower its prices.

What happens to the stock?

The final piece of the puzzle might be the overly bullish sentiment of analysts, and revised outlooks that could drive share prices lower. Back in August, analysts gave Cree the benefit of the doubt. Piper Jaffray immediately came out after its August quarter suggesting consumers are willing to pay a premium for Cree's LED bulbs. Goldman maintained its Buy rating, saying Cree's troubles were only "growing pains". Wedbush said the weakness created an opportunity and JPMorgan believed that margin concerns were "overblown".

In retrospect, it might have been the calming words of these firms that helped rejuvenate shares of Cree after its last dismal quarter. However, after this latest report we are seeing a different tone, as both Stephens and Needham have already downgraded the stock. With that said, analysts and the company are running out of excuses, and given this weakness, I wouldn't be so anxious to buy on this earnings-induced dip.

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. I have no business relationship with any company whose stock is mentioned in this article.