Cree Earnings Brighten On Better Margins And LED Market Recovery

Despite sluggish macro trends, Cree (NASDAQ:CREE) managed to start its fiscal 2013 on a positive note. A leading LED manufacturer, Cree posted its Q1 2013 earnings on October 16 with $316 million in revenue and a net income of $16 million. Though revenue marked a mere 3% sequential increase, the net income was up by close to 60% compared to Q4 2012.

While a demand-supply mismatch put pressure on Cree’s topline, high R&D cost and operating expenses threaten its bottom line. However, the company closed its Q1 2013 with a lower than targeted operating expense and a much needed improvement in gross margins.

We feel that Cree is well positioned to leverage the potential growth in LED market in the long-run. It remains committed to drive LED adoption by optimizing performance and lowering costs to close the gap with conventional lighting. We believe that a focus on investing in new product development and initiatives to drive product sales which help Cree regain its growth momentum.

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Improving Gross Margins

Owing to depressed prices and higher operating expenses, Cree’s gross margin dropped down from 48% in 2010 to 37% in 2011, and the downward trends continued in the subsequent quarters as well. After eight quarters of consecutive declines in gross margin, Q3 2011 offered some respite with a slight increase in margins. While margins remained flat in Q4 2012, they rebounded to 37.5% in Q1 2013 on account of higher factory utilization and low cost new products.

As the economy stabilizes, we feel that higher revenues for a similar cost base could lead to additional improvement in margins. Cree remains focused to improve factory utilization leading to increased factory cost reduction. However, with the shift in product mix toward lower margin fixtures and a potential increase in competition as LEDs gain ground with the traditional incandescent light bulbs and CFL technology users, we expect the margins to remain more or less around the same level.

Continuous Growth in LED Sales

With the demand from the backlight market nearing saturation and the general lighting market yet to take off, the growth in LED demand has been slow resulting in a huge demand-supply gap that has put downward pressure on the average LED selling price. The increase in LED supply led by Chinese manufacturers has resulted in the LED surplus rising from a relatively low 7% in 2010 to 45% in 2011.

However, Cree witnessed an increase in orders for both the lighting and LED segments last quarter which translated into higher revenues in Q1 2013. Witnessing improvement from both the agent and direct sale channel, Cree’s lighting sales grew by 7% q-o-q and the LED sales increased by $2 million from the previous quarter.

Cree remains focused on driving LED adoption & increasing sales of its indoor and outdoor products. We feel that its acquisition of Ruud Lighting, a leader in outdoor lighting, in mid-2011, allows Cree to extend its leadership in indoor as well as outdoor lighting. Lighting is estimated to be the fastest growing segment in the LED industry and we feel that Cree is well positioned to leverage the growth here.

With the introduction of a number of innovative products, Cree’s LED adoption continued to gain momentum in Q1 2013. Cree plans to increase its sales and marketing efforts to expand its customer base and also leverage new products to deliver revenue growth and margin improvement in the coming quarters. We estimate Cree to register a continuous increase in its market share for the rest of our forecast period.

We are in the process of updating our current price estimate of $26.20 for the latest earnings release.

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