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We believe that consensus expectations are overly conservative on LED equipment maker Veeco (NASDAQ:VECO), as the company has until now reported pretty weak orders. This leaves significant room for earnings surprises in 2014, in our view: LED end-demand currently is healthy and is driving strong utilization rates at LED manufacturers such as Cree (NASDAQ:CREE), which is likely to spark equipment investment decisions.

Veeco constructive on its 2014 outlook

Last week, Veeco reported Q4 revenues of $73m, 5% above consensus, and announced a Q1 guide of $85m-95m vs. consensus at $80m. Q4 bookings were still weak at $85m and down -7% quarter-on-quarter and even worse (-22% quarter-on-quarter) in the MOCVD segment (used in the manufacturing of LEDs), but it looks like they have troughed. First, the number did not include an order for a next-gen ALD tool announced in the press release. Second, management's tone on the 2014 outlook was quite constructive, with Veeco hinting a recovery in orders driven by capacity expansion at LED manufacturers.

We agree with the company: LED lighting rising adoption is a reality, as demonstrated by LED lighting revenue growth in Q4 ranging from +28% at Osram (OTCPK:OSAGF) to +42% at Cree and +48% at Philips (OTCPK:PHGFF). We believe that we are still at an early stage of the growth curve and that LED adoption is likely to accelerate in 2014 thanks to declining retail prices and the gradual phasing out of incandescent bulbs. Until January, only the 75W and 100W incandescent bulbs were banned in the US but now the ban also includes the best-selling 40W and 60W. And in China, the 60W incandescent bulbs will be banned from October.

As LED manufacturers benefit from rising demand and utilization rates (approaching the 90% level at many factories), they are likely to spend on new infrastructure in order to increase yields and production. As an illustration, Sanan Optoelectronics recently announced its intention to add 100 MOCVDs on its Wuhu site.

This rising confidence in the industry capex spending and in Veeco's revenue outlook comes at a time of increased financial discipline at Veeco, with cost savings in the MOCVD business expected to drive gross margin up 1300bps quarter-on-quarter in Q1. This suggests a significant earnings leverage going forward, assuming the top-line recovers as we expect.

Very attractive risk / reward

In all, we view the downside risk on Veeco as extremely limited as orders have been extremely weak until now and as consensus has been very conservative. The upside could be huge if our bull scenario materializes as Veeco could benefit from higher volumes, rising prices and significant margin leverage and as the stock displays a high beta.

Disclosure: I am long VECO. 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.

Source: Veeco: The Inflection Point Is Now