Cree, Inc.'s (NASDAQ:CREE) share price has recovered slightly after falling to $27.28 on October 22nd. Nonetheless, Cree continues to remain on a downward trend. Value investors should watch this stock carefully as I would recommend buying if prices continue to decline.
Cree has a sustainable competitive advantage in LED
One positive for Cree is that it functions in an industry that is still in the very early stages of growth for general lighting applications. Although LED lighting technology has not achieved much market penetration, a recent McKinsey report highlights that it may make up more than 50% of all lighting segments (residential, commercial, industrial, outdoor) in the next few years. In many analysts' views, there is a tremendous market opportunity and Cree is well set to exploit it.
Cree has good prospects in the LED industry as it has been granted over 940 US patents and approximately 1,800 foreign patents. However, Cree has not merely rested on its laurels. Its products have continuously been at the cutting edge ranking well for efficiency and Color Rendering Index "CRI" metrics.
Government incentives to play a big role
There are numerous government benefits in pursuing a policy of LED adoption. LED bulbs are approximately 80% more efficient than the incandescent light bulb. The Department of Energy estimates that 300 terawatt hours of energy could be saved by the US by 2030. To put in perspective, this is the equivalent energy needed to power 24 million homes which represents approximately $30 billion in energy savings.
Levered Returns Valuation Model
I have used rather conservative assumptions in my model with the growth rate progressively falling from FY 2016 to FY 2019. The LED market is expected to grow by 30% in 2015 which explains my optimistic projection for 2016 at 14%. Long term EBITDA margins are projected to reach 21%, slightly higher than the 18% projected for 2015. These revenue and profitability assumptions result in the company having an enterprise value of approximately $2.7 billion. Adding net cash from the company's balance sheet provides an equity value of approximately $3.8 billion resulting in a per share fair value of $31.30.
Cree is an attractive long-term investment but looks to be trading right around its fair value. I would recommend investors look into buying Cree if its share price continues to decline. However, play with the assumptions in the model above to determine the right entry point for yourself.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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