Here's Why Cree Is Still Worth $63

| About: Cree, Inc. (CREE)

Cree’s (NASDAQ:CREE) stock price has declined by more than 20% since the company reported its Q2 2014 earnings on January 22. While Cree reported a strong quarter with 19% annual and 6.2% sequential growth in revenues, the weaker than expected guidance for Q3 2014 did not go down well with the investor community. Cree guided that its revenue would decline marginally or remain flat in Q3 2014, as LED demand is expected to decline sequentially due to the Chinese New Year holiday. Cree derives over 35% of its revenue from China.

Since the expected slowdown in growth this quarter is more on account of seasonal trends, we continue to believe in Cree’s long-term growth potential. LED penetration is expected to increase in the future and being one of the leading global LED manufacturers, Cree will benefit from the trend, in our view. With $1.1 billion in cash and no debt, the company has a strong balance sheet, which gives it the ability to invest in growing its business and respond to new market opportunities.

Our price estimate of $63 for Cree is at an approximate 10% premium to the current market price. In this article, we list down key factors that support our valuation.

LED Adoption To Rise In The Future Driven By The Lighting Segment

With increasing global awareness about the economic and environmental benefits of LEDs, adoption is rising at a fast pace. LEDs offer energy savings of 50%-60% over incandescent alternatives, leading to lower greenhouse gas emissions and a much higher lifespan compared to conventional technologies. LEDs offer a cost effective option to lower global electricity consumption, especially as economies of scale allow for lower average selling prices. The sales of LED light bulbs in America have enabled over $1 billion in lifetime energy savings for consumers.

As countries around the world aim for greater economic and social development, LED adoption should accelerate in coming years. As per the 2007 Energy Independence and Security Act, it is no longer legal to produce or import 40-watt and 60-watt incandescent bulbs in the U.S. The 100-watt and 75-watt variants were phased out in 2012 and 2013. Improving economic conditions, innovative new products (such as the LED bulb available for $10) and the narrowing price gap between LEDs and conventional technologies are all key factors driving LED adoption.

The general lighting market is expected to be the primary growth driver for the LED industry. LED lighting accounts for 15%-20% of the global lighting market at present and the LED market share is expected to rise at a rapid pace over the next decade. Presently, LED’s accounts for only 1% of the U.S. lighting market, and thus remain a largely untapped opportunity.

With Rapid Innovations CREE Remains One Of The Leading LED Manufacturers

Cree is one of the leading LED players committed to driving global LED adoption and closing down the price gap with conventional lighting through innovation. Product innovation in the last few quarters has opened new applications and improved LED returns, in turn driving demand for Cree’s products. The company has a fully integrated vertical business model and is the market leader in both LEDs and LED lighting products. This places it in a strong position to leverage the growth in LED adoption.

Below are some recent product launches and developments that affirm Cree’s competitiveness in the LED market:

- Cree’s Low Cost LED Bulb: Cree hit a milestone in driving LED adoption a year back by launching a LED bulb for as low as $10. The LED bulb is considered as one of the biggest industry innovation in years and has been seeing tremendous success at Home Depot stores. In November 2013, the Cree LED bulb earned the ENERGY STAR label, which means these bulbs qualify for incentive rebates through certain local utilities. With the rebate, the Cree LED bulbs is available for under $5. Driven by a full lighting season, utility rebate, new products and increased marketing activities, Cree’s LED bulb sales to consumers doubled sequentially in Q2 2014.

Cree has expanded its LED bulb portfolio with a 75-watt (consumes 84% less energy and provides similar levels of brightness compared to traditional incandescent bulbs) as well as a 100-watt replacement bulb, which at $19.97 is the lowest-priced 100-watt LED replacement bulb. The company has also lowered the prices of the Cree LED Bulb product line by as much as 23%, which we believe will further accelerate sales in coming months.

- True White Series: Cree became the first company to comply with the voluntary standard set by California regulators to make bulbs more closely resemble the warm white light from traditional incandescent bulbs. The company launched a new LED bulb, the TrueWhite series, which comes close to the quality of light from a 60-watt incandescent. Available in the range of $18-$20, the Cree LED bulb has a color rendering index (NYSE:CRI) of 93 and a score of 100 is the closest to natural light that a bulb can get. The True Light bulb uses 78% less energy and lasts 25 times longer compared to traditional incandescent light bulbs.

- $99 Street Light: Cree’s XSPR Series Street light is the first $99 LED streetlight designed to compete head-on with low-cost, high-pressure sodium streetlights in residential applications while delivering 65% energy savings and a significant upgrade in light quality.

In the long run, Cree aims to drive mass LED adoption and achieve 100% upgrade to LED lighting by its customers.

Disclosure: No positions