Cree - Sell-Off Offer Entry Point In This Quality Name

| About: Cree, Inc. (CREE)
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Shares of Cree (NASDAQ:CREE) saw quite a sell-off in after-hours trading on Tuesday after the LED producer gave a somewhat cautious outlook for the second quarter, at least in comparison to hyped analysts consensus.

The sell-off provides long term investors with a nice opportunity to pick up some shares for the medium to longer term.

First Quarter Results

Cree generated first quarter revenues for its fiscal 2014 of $391.0 million, up 23.8% on the year before. Analysts estimates had risen to $392.3 million.

Net earnings rose by some 89.4% to $30.5 million in the meantime, as earnings per share rose by 79% to $0.25 per share.

On a non-GAAP basis, Cree reported earnings of $47.3 million, which is up by 49% compared to a year earlier. Non-GAAP earnings per share came in at $0.39 per share, exactly in line with consensus estimates.

CEO and Chairman Chuck Swoboda commented on the first quarter developments, "Fiscal 2014 is off to a good start, as we delivered solid Q1 revenue and earnings growth in line with our targets. The strong performance was primarily due to increased sales of our lighting products, higher gross margins and improved operating leverage across the business. Based on our backlog, current sales activity and project forecasts, we are targeting growth in all product segments in Q2."

Looking Into The Results..

Cree saw growth in all of its segments. LED product revenues were up by 16% to $218.0 million. Yet all the focus was on the Lighting Products business which reported a 37% increase in revenues, coming in at $147.9 million. The minor Power and RF unit reported 24% revenue growth to $25.1 million.

Revenue growth was accompanied by solid margin expansion as gross margins improved by 180 basis points to 38.6% of total revenues. Notably the LED business performed well with a 640 basis point increase in margins to 46.6% of revenues. Disappointing was the steep 470 basis points decrease in margins for the Lighting Products business, falling to just 26.9% of sales.

The minor Power and RF unit reported very solid margins at 53.7% of revenues.

Yet revenue growth and overall margin expansions resulted in a solid boost to earnings.

..And Looking Ahead

For the current second quarter, Cree is guiding for revenues of $400 to $420 million, with GAAP gross margins of around 37.8%

At the midpoint of the revenue guidance, revenues are seen up by 18.2% on the year before, and up by 4.9% compared to the first quarter. Also note that margins will come under pressure, expected to fall by 80 basis points in the first quarter on higher growth in the Lighting Products unit, which carriers lower margins, and $5.5 million in additional promotional expenses for the Cree LED bulb. On average, analysts were looking for revenues of $414 million.

Second quarter GAAP income is seen between $26 and $32 million, or between $0.21-$0.26 per diluted share. This compares to first quarter earnings of $0.25 per share, and earnings of $0.14 per share last year.

Non-GAAP earnings are seen between $0.36 and $0.41 per share, trailing consensus estimates of $0.44 per share, as Cree incurs additional promotional expenses for the LED bulb.


Cree ended the first quarter with $1.09 billion in cash, equivalents and short term investments, while the firm holds no debt.

Revenues for the full year of 2013 came in at $1.39 billion, up 19% on the year before. Net earnings nearly doubled to $87 million for the year.

Factoring losses of 15% in after-hours trading, with shares trading around $63 per share, the market values Cree at $7.5 billion. This values operating assets of the firm at $6.4 billion, or 4.6 times annual revenues and around 75 times annual earnings.

Cree does not pay a dividend at the moment.

Some Historical Perspective

Over the past decade investors in Cree have seen quite some volatility, but it was all net positive. Between 2004 and 2009, shares have traded in a $20-$40 trading range, to peak around $80 at the start of 2011.

Shares fell back all the way back to $20 in 2012 to rise from levels around $30 in January of this year to a peak of $75 in August and recent days. Note that shares have given up quite some ground again in after-hours trading.

All this positive price action has been driven by growth. Revenues increased by a cumulative 60% to $1.39 billion between 2009 and 2012. Note that net earnings nearly halved to $87 million in the meantime, while the share base outstanding increased by some 20%.

Investment Thesis

When you invest in growth names like Cree, you have the risks to run into these days. Essentially, the market values the company at $1.3 billion less compared to Tuesday's close because the quarterly earnings miss estimates by just a few million.

That being said, these "exaggerations" offer prepared investors an opportunity to invest in some quality names at more appealing prices.

Essentially Cree's share price and valuation relies heavily on the success of LED lighting, with superior economics, in the coming decade. While Cree is a true leader at the moment, these development have already attracted competition from the likes of General Electric (NYSE:GE) and Philips (NYSE:PHG), among others.

Right now, Cree is focusing on adoption of its products and the company is happy to sacrifice margins to achieve that goal, partially by making additional marketing efforts. Crucial in this strategy is the nice tie-up with Home Depot (NYSE:HD) which features its LED bulbs in over 2,000 physical stores. In fact, Cree's LEB bulb won the Home Depot 2013 Innovation Award in recent weeks.

Note that the economics of these bulbs are amazing with energy usage being just around 15% of that of traditional bulbs, while they can last upto 25 times longer. Note that retail prices of $12.97 are relatively steep, but these are no outrageous prices given the economics of savings of $12 per bulb per year.

The speed at which Cree has developed and launched the product remains amazing with the bulb still being an idea just a year ago, now marking the first consumer product of the firm. As such investors, should not look into the margins for now, as Cree is in this for the long haul. The firm tries to establish a dominant position to create more long term value, rather than to look for some short term gains.

Just three weeks ago, I last took a look at Cree's prospects after analysts were pushing up expectations for these first quarter results. I concluded to await this earnings report to learn more about the success of the LED's before taking a position. Essentially results are in line with expectations, but current levels offer a nice opportunity to pick up some shares at a 15% discount.

As the product is technically and economically superior, it all depends on marketing and Cree's market position. Fortunately the Lighting Products business did just well, reporting a solid 37% increase in revenues.

At the time, I concluded that Cree could possibly attain revenues of $3 billion by 2016, depending on the success of the LED's. Operating margins should be able to see significant leverage as well, being able to come in around the mid-teens percentages, for operating earnings of $400-$500 million per year.

This seems reasonably fair in combination with operating assets being valued around $6.4 billion at the moment. This values the business at 2.1 times annual revenues and around 14 times earnings. While I am a little bit worried about continued but modest dilution in recent years, I might initiate a long position through shares or options in the coming days or weeks, expecting shares to test $100 per share into 2014.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.