Growth Potential In LED: Factors Driving Cree’s Valuation
Cree (NASDAQ:CREE) is a leading manufacturer of light emitting diodes (LEDs), LED lighting and semiconductor solutions for wireless and power applications. As one of the leading players in this domain, along with Nichia, OptoSemiconctor Toyoda Gosei (OTC US:TGOSY) and Epistar Corporation (LI:EPIS), Cree is committed to increase LED adoption and close down the gap with conventional lighting by optimizing LED performance and lowering costs.
Contributing close to 72% to our price estimate of $28.62 for Cree, LED chips, LED lighting and LED components are the most important divisions in the company’s portfolio. While we estimate the market share to increase due to expanded manufacturing facilities and the acquisition of Rudd, we feel that the growth of the global LED market is a more important driver for the company’s overall valuation.
In this article, we list certain factors that reiterate our belief in the LED market growth rate as well as possible scenarios which can lead to an additional upside in our price estimate.
See our complete analysis for Cree
What is the estimated size of the LED market in the next 5 years?
The LED market has more than doubled in size in the last 5 years from close to $5 billion in 2006 to around $12.5 billion in 2011. We estimate the market to grow at a CAGR of 8% going forward and reach approximately $24 billion by the end of our forecast period. While LED’s currently account for only 10% of the total lighting market, it is estimated to increase to as high as 60% by 2020. [1]
With energy savings of 50%-60% 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.
What are some factors that could contribute to a faster growth rate ?
Many economies, especially in emerging markets, are witnessing rapid urbanization, which is leading to greater opportunities for economic and social development. However, the same creates resource scarcity and raises environmental concerns. Countries are starting to recognize the opportunity LEDs provide to help them significantly reduce their energy costs and lower maintenance charges.
In major market segments – such as commercial, industrial and outdoor lighting – LEDs have only a 10% market penetration, whereas in the residential sector (perhaps the most promising) the penetration stands at a mere 1%. [2] We believe that this gives the global LED market tremendous scope for growth.
If the global adoption of LEDs increases faster than we anticipate, there can be a significant upside to our price. Assuming that the LED market reaches $30 billion in revenues by 2019, the end of our forecast period, we can account for around 18% upside in our price estimate.
What are the possible roadblocks that can slow down the projected growth rate?
While the benefits of LEDs are apparent, rapid adoption is not an easy task. LEDs have high up-front costs, which acts as a deterrent for many users, especially in the emerging markets. If macroeconomic headwinds continue for a longer time it can slow down the rate of adoption. Additionally, increasing awareness about the economic as well as environmental benefits of LEDs remain a challenge as the technology changes rapidly and policy changes are met with bureaucratic red tape.
Which regions are the most promising in terms of higher LED penetration?
China, Europe, Japan, South Korea, Taiwan and the United States are some of the leading LED producers in the world, whereas nations such as India and Russia still fall in the emerging category for LED production. Apart from being the world’s leader in LED manufacturing, China also accounts for 46% of the global consumption of high brightness LED, compared to 30% and 17% in North America & Europe respectively.
In its 12th five year plan (2011-2015), China aims for LEDs to achieve 30% market share of its general lighting market by 2015. Estimated to grow at an annual compound rate of 49%, China is expected to have the largest LED lighting industry in the world for years to come. [1]
Geographic split of Cree’s revenue over time
Realizing the growth potential of the Chinese economy, Cree has significantly expanded its manufacturing facilities in the country over the years. While only 14% of its property and equipment was concentrated in China in 2008, the percentage increased to 26% in 2011. Cree currently derives approximately 36% of its revenues from China, and remains focused on expanding its presence in that market in the future.
|
Revenue by Country (Source: Cree SEC Filings) |
|||||
| Country | 2007 | 2008 | 2009 | 2010 | 2011 |
|
China |
21% |
33% |
38% |
40% |
36% |
|
US |
20% |
18% |
20% |
19% |
24% |
|
Europe |
15% |
6% |
10% |
13% |
14% |
|
South Korea |
4% |
16% |
15% |
10% |
4% |
| Japan |
25% |
13% |
9% |
9% |
7% |
|
Malaysia |
9% |
6% |
3% |
2% |
2% |
|
Taiwan |
5% |
4% |
3% |
4% |
5% |
|
Other |
1% |
4% |
2% |
3% |
8% |
|
Total |
100% |
100% |
100% |
100% |
100% |
What is the possible upside if Cree targets certain other untapped economies?
Cree currently does not have much of a presence in certain other promising markets such as India and Russia. However, if the company plans to significantly expand in either of the markets during our review period, it could lead to a potential upside in our price estimate.
The lighting market in India is currently valued at $1.4 billion and is estimated to increase at an annual rate of 18%. [2] If we assume that 2014 onwards Cree caters to 5% of the total LED demand in India, then it can lead to a 9% upside to our price estimate (See Note 1 for calculation). Similarly, if Cree expands its presence in other markets which have potential for LED growth it could see a higher upside to its valuation.
Cree reported its Q1 2013 earnings on Tuesday, October 16, and despite sluggish macro trends the company started its fiscal with a strong quarter. (Read: Cree Earnings Brighten On Better Margins & LED Market Recovery and Key Concerns Impacting Cree’s $29 Valuation)
Note 1 – If we assume that the Indian LED market grows at a constant rate of 18% through 2019 and add 5% of the value to Cree’s forecasted revenue, we can arrive at the estimated market share using the following formula: Cree LED revenue/ Global LED market size. Incorporating the new market share value in our model we get $31.19 as the revised price estimate.
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Notes: