Cree: A Growth Stock in a Booming Segment

| About: Cree, Inc. (CREE)

By Brendan Coffey

By one estimate, lighting in the U.S. commands 22% of electricity usage.

Shifting to CFL bulbs helps since they are three times more energy efficient than incandescent bulbs. But because they use mercury, which has dire consequences on wildlife, CFLs are seen as simply a stop-gap measure until the next wave of lighting matures.

This next generation technology is LED, or light-emitting diode. Like the name suggests, LEDs aren’t bulbs like we think of them, but a collection of small silicon chips-like instruments that emit a certain color of light. They use so little electricity that when Prince Charles of England switched Buckingham Palace’s exterior lighting to LEDs, illuminating the palace at night takes as much energy as one of the electric teakettles that are so common in his country.

LEDs have the added bonus that they rarely need to be changed–the expected lifespan is 20 years. That holds great appeal to municipalities, who spend a lot of money on streetlight and parking garage electricity and maintenance. Los Angeles is retrofitting 140,000 streetlights with LEDs for just these reasons. San Jose, Anchorage and many other cities are performing smaller retrofits with their federal stimulus funds.

Corporations see the benefits, too. Walmart (NYSE:WMT) recently installed LED lighting in 638 of its stores’ electronics departments and has found an 82% reduction in electricity costs in those departments as a result. It may roll out LED usage chain-wide.

A North Carolina McDonald’s (NYSE:MCD) restaurant installed LEDs throughout its location and found a 78% drop in electricity costs. Other quick-serve restaurant locations from Yum Brands (NYSE:YUM) and Friendly’s have found similar savings.

But such cost efficiency and lifespan comes at a cost. LED retrofit lights can cost hundreds of dollars each, compared to a dollar or so for a traditional incandescent bulb.

Still, costs are destined to come down and it’s cheaper to install LEDs in new construction. Today, LEDs are still just 1% of the $120 billion worldwide lighting market. Because of their inherent advantages, one major LED manufacturer, Philips, predicts the LED market will grow 1,000% in the next 10 years. My stock pick isn’t Philips, but a North Carolina-based competitor we detailed to Cabot Green Investor subscribers this month, Cree Inc. (NASDAQ:CREE). Half of Cree’s $597 million in 2009 sales (which generated 34 cents a share net earnings) came from municipal and residential LED products. This is an area largely ignored by many LED makers who prefer to sell to cell phone and laptop makers, which Cree also does.

In addition to supplying LEDs to Walmart’s conversion, the company recently bought a major Chinese LED manufacturer, which is accelerating sales in China and also providing a lower-cost manufacturing base. By one estimate, the achievable LED market in China would provide energy savings equal to the power generated by the Three Gorges hydroelectric dam project.

Trading at 52 a share, Cree is pricey at 100 times trailing earnings. Still, history tells us the best growth stocks are often expensive. Wait for shares to back off a few dollars into the high 40s before buying.

Disclosure: none