Cree (CREE) made an important bet on the LED consumer market last year by launching an LED bulb priced below $10. This new bulb consumes 84% lesser energy and provides similar levels of brightness compared to traditional incandescent bulbs. LED lighting penetration in all U.S. lighting sockets is currently 1%, and due to increased replacement in the country, this penetration will increase at a brisk rate in the years to come. LED lights are more efficient and have a longer lifespan than traditional incandescent lights. This enables consumers to reduce their energy costs and usage, which ultimately reduces the amount of greenhouse emission on energy production.
The U.S. government has been implementing measures to promote penetration of LED bulbs, and it also implemented harsh measures to phase out conventional incandescent bulb from the market. In part of an energy bill signed by George W. Bush, the government recently banned the manufacturing of 40W, and 60W incandescent bulbs beginning January 1, 2014. This ban is an extension of already banned 75W and 100W incandescent bulbs, which were phased out last year. The ban on widely used 40W and 60W incandescent bulbs will cause consumers to purchase options that are more efficient like compact fluorescent bulbs, or CFLs, and LEDs.
This ban will help Cree's long-term goal of achieving mass LED adoption and 100% upgrade to LED lighting by its customers. The company sustained its growth momentum in the second quarter of fiscal year 2014 with revenue increasing 20% year over year, while its earnings per share stood at $0.46, up 44% year over year, thus beating the market estimate of $0.39 per share. Sales of Cree's lighting products, which include LED bulbs and LED fixtures, were up 42% year over year and 17% quarter over quarter on account of increased adoption of LED lighting products in the market. Sales of Cree's LED bulbs to consumers doubled in the second quarter compared to the first quarter. A utility rebate, new products, and increased marketing activities by the company sparked this sales growth.
In its last fiscal quarter, the company further expanded its LED lighting product offerings with introduction of the new 75W Replacement LED bulb, which looks and lights like a traditional incandescent bulb but uses 82% less energy and is designed to last 25 times longer. Since breaking the $10 price barrier for LED bulbs in March last year, the company has been busy expanding its product portfolio. It launched the LED BR30 Flood Light, which is based on many of the same components as its sibling product line, Cree's 60W equivalent A19 bulb, and uses 85% less energy while lasting 25 times longer than the comparable incandescent option. In addition, the company also introduced the industry's first $99 LED Street Light in August last year, which consumes over 65% less energy than the conventional alternative, and its True White LED series bulb made Cree the first company to fulfill the California Energy Commission LED bulb specification.
All these products have helped the company expand its footprint in the overall LED lighting market. In addition, the company has also leveraged the statutory incentive prevailing in the U.S. for boosting the sales of its product. Cree's LED lamps, i.e. 40W replacement and 60W replacement, are certified under the Energy Star rating, which makes these products eligible for a rebate up to $5 from utility companies. This rebate removes the price disadvantage of LED bulbs, and thereby promotes LED bulb replacement. Thus Cree's 6W LED bulb, which replaces the 40W incandescent bulb, now cost $4.97 compared to the earlier price of $9.97. Its 9.5W LED bulb, which replaces the 60W incandescent bulb, now cost at $7.97 per piece, from an earlier price of $12.97. This price reduction provides a further boost to LED bulbs sales as it close the price gap between LED and incandescent bulbs.
Price factor plays an important role in driving the sales of LED bulbs, and with the addition of utility rebates, the company can attract more buyers. Increase in adoption of LED lighting also boosts Cree's LED products segment, which is the largest segment of the company. This segment consists of LED chips and LED components, which benefit from overall LED adoption in several applications like lighting, backlighting in TV displays, etc. For the second quarter, this segment's revenue was up 7% year over year, and with the growth in the adoption of LED lighting, this growth rate will increase further in the future.
Blazing a path despite competition
Despite stiff competition in the market from well established players Koninklijke Philips (PHG) and General Electric (GE), Cree has successfully established its market presence due to its innovative products. Both its competitors have product diversification and resources to dominate the market, but Cree still managed expanded its market presence. The company has leveraged its vertically integrated manufacturing and technological improvement to break the $10 price barrier for a LED bulb, when its competitor's products were priced much higher at that time. Cree is actively pursuing a cost reduction program to lower manufacturing costs and improve margins. Cree's cost reduction program involves innovating new ways to reduce the cost of LEDs. The company wants to re-optimize the parts of the design and try different things, without affecting the performance of the products.
On the other hand, Philips has established the leading position in the LED market worldwide, and like Cree, the company has a vertically integrated model, which has helped it gain complete control over the entire value chain, bringing costs down to optimum levels. During the third quarter of 2013, Philips' LED sales posted strong growth of 33% year over year. In partnership with utility companies, the company is offering some of the cheapest LED bulbs, priced at $5 per piece. Professional customers were the early adopters of the company's LED products, but the company expects increased penetration in the consumer segment due to its competitive pricing.
Another important aspect of Cree's success has been its partnership with Home Depot (HD), which resulted in the success of Cree's LED products in the tough consumer segment. Home Depot has a footprint of 2,260 stores in 50 states, and shelving of Cree's LED products has resulted in strong sales figures. Cree plans to expand more bulbs at different prices this year, providing more options to consumers. The increased number of Cree LED lighting products coupled with Home Depot's strong presence will further boost sales. It will continue to work with the retailer next year, and the company has already started looking for complementary channels to reach non-Home Depot consumers.
I believe Cree's innovation will help the company capitalize on the market opportunity and give tough competition to big player like Philips. Also, partnership with Home Depot will provide strong growth in the consumer segment and help it combat growing competition from other retailers like Wal-Mart (WMT), which launched an all new range of LED lighting products recently under its own brand name, Great Value. Wal-Mart has strong presence all over U.S., and the company can leverage its strong financial statement to take on the burden of margin decline caused by price reduction. Wal-Mart's Great Value bulbs are available at sub-$10 prices, and this aggressive price strategy is aimed at luring customers to the Wal-Mart LED bulb. Thus, Wal-Mart LED bulb products are a substantial threat to Cree's low priced LED bulbs. However, Cree's bulbs are the beneficiary of utility rebates, which enable the company to keep prices competitive in the market. Partnership with Home Depot also provides the necessary distribution channels to reach the masses.
Cree's second quarter result mirrors the strong growth momentum that the company will witness in the upcoming years on account of the increased adoption of LED products in the lighting market. Regulatory tailwinds, like the ban on incandescent bulbs and utility rebates, will also provide strong market opportunities. In addition, partnership with Home Depot and expansion of its LED product offerings coupled with Cree innovation will help it gain market share despite stiff competition. LED lamps and luminaire sales are expected to reach 36% of sales measured in lumen-hours on the general illumination market by 2020 and 74% of sales by 2030.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Fusion Research is a team of equity analysts. This article was written by Rohit Gupta, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article