Cree Faces an Uphill Task after a Poor Quarter
Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors in light-emitting diode maker Cree (NASDAQ: CREE) have had a great year so far with the stock gaining 45%. But they must be feeling the pinch now as the company posted a woeful third quarter. Cree failed to meet market expectations, sounded out a depressive guidance and shares fell 7.5% in extended trading.
Let’s take a look at what went wrong for Cree and how it might fare going forward.
Looking beyond the revenue jump
Revenue in the quarter rose 30% to $285 million from the year-ago period but fell short of analyst estimates of $300 million. That top line jump might seem impressive but it includes revenue from Ruud Lighting, which Cree had acquired in the first quarter this year. The upbeat nature of the revenue jump subsides when we take a detailed look at the results. We see that lighting sales fell $9 million and LED sales fell $13 million from the year-ago period and this is a grave cause for concern. Let’s see why.
Declining prices are a major challenge
LED product and lighting sales together constitute more than 90% of Cree’s revenue and have been under constant pressure due to falling prices, stiff competition and seasonality. Chinese players have inundated this market with cheaper products, thus resulting in an inventory glut and falling prices. And if analysts are to be believed, there could be no respite in the offing for Cree as LED prices are expected to go down as much as 90% over the next three years. So even though the LED market is expected to grow, the decline in prices is a serious threat for Cree.
Shrinking margins
Management tried to put up a brave face when saying that gross margins improved 30 basis points sequentially. But declining prices hurt Cree’s margins significantly with its gross margin shrinking to 35% in the quarter from 42% a year ago. Management says that cost-reduction efforts did bear some fruit in the just-concluded quarter and they are focused on bringing costs further down through higher capacity utilization. However, it remains to be seen to what extent this would help Cree in salvaging its margins in the wake of falling prices.
What next?
Cree has been pushing hard on the innovation front and has introduced a number of new products with better efficiency and expects them to drive LED adoption and the company’s growth. Also, the company says its order backlog is quite strong and it is seeing improvement in orders. However, the problems posed by industry dynamics are significant headwinds. Moreover, the patent infringement litigation, which Cree brought onto itself along with Ruud Lighting, is another area of concern.
Cree expects sales from all three of its product lines to improve in the current quarter, expecting revenue in the range of $295 million to $315 million. But this is well behind the $323 million modeled by analysts. The stock has been upbeat all through the year but with the way things are going, a pullback might be in the cards.
The Foolish takeaway
Fool analyst Anders Bylund rightly points out that LED lighting is a viable alternative to light bulbs that aren't considered environment friendly due to CO2 emissions, and Cree is one of the leading companies supplying LED lights. But as this happens, there might be more players warming up to enter the fray. Anders says that Cree might face stiff competition from bigger fish such as General Electric's (NYSE: GE) lighting division. The company already supplies LED lighting products and can scale up its production as LEDs find more acceptability, thus creating more pressure on the already depressed prices. As such one needs to wait till the industry consolidates and prices stabilize, since you would wish to enter the stock when it has bottomed out and reap the benefits of this growing industry. Till then, I would watch Cree from the sidelines and check for signs of a bounce back.
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