How Is Cost Of Sales Shaping Cree’s Overall Profitability?

Cree’s (NASDAQ: CREE) total expenses have grown steadily from $860 million in 2017 to $1.14 billion in 2019. As a percentage of total revenues, expenses dropped, going from 111.4% in 2017 to 105.4% in 2019.
Cost of sales is the biggest expense head for the company, with it being 68.4% of revenue in 2017, before dropping to around 63.8% of revenue in 2019. This, combined with a steady growth in revenue, has helped drive EPS from -$0.89 to -$0.56 over this period.
Also, going forward, cost of sales as % of revenue is expected to drop further, leading to a projected increase in net income margin from -5.4% in 2019 to 0.2% in 2021.
This projected growth has helped drive a 30% rise in Cree’s share price over the past 2 years.
In our interactive dashboard How Does Cree Spend Its Money?, we take a look at the key drivers of Cree’s expenses and net margins.

Cree’s Net Income Margins have remained volatile, rising sharply from -11.4% in 2017 to -1.8% in 2018, before dropping to around -5.4% in 2019. Going forward, margins are expected to rise steadily, to -3.8% in 2020 and then 0.2% in 2021.

Breakdown of Cree’s Total Expenses

• Cost of Sales has grown from $528 million in 2017 to $689 million in 2019, in line with steady revenue growth. As a % of Revenue, Cost of Sales has dropped from 68.4% to 63.8% over the same period. This has largely been due to a growth in selling prices, especially for Power and RF products from the Wolfspeed Segment. We further expect this metric to drop to 61.7% by 2021.
  
• SG&A Expense has grown steadily with a rise in revenue, going from $145.7 million in 2017 to $200.7 million in 2019. As a % of revenue, SG&A expense dropped marginally from 18.9% to 18.6% over the same period. Going forward, we expect this expense to come in at 18.8% in 2020 and 18.5% in 2021.
• R&D Expense grew from $113.8 million in 2017 to about $157.9 million in 2019, in line with Cree’s steady revenue growth. As a % of Revenue, R&D expenses remained roughly the same, going from 14.8% to 14.6% during the same period. We expect this metric to rise slightly in 2020 to 15.2%, before coming back down to 14.4% in 2021.
• Amortization and impairment charges grew from $5.2 million in 2017 to $20.3 million in 2019. As a % of revenue, this expense went from 0.7% to 1.9% over the same period. We expect this metric to come in at 1% of total revenue in 2020 and 2021.
• Other operating expenses went from -$0.6 million in 2017 to about $28 million in 2019. This metric primarily includes restructuring charges and other miscellaneous expenses. We expect this metric to come in at around 2% of total revenue in 2020 and 2021.
• Non-Operating Expense has increased from -$13 million in 2017 to $29.3 million in 2019. There was a rise in 2019, due to higher miscellaneous non-operating expenses related to the divestment of the lighting business. Total debt for Cree has dropped from $145 million in 2017 to $0 million in 2019. Going forward, we expect non operating expenses to grow to around $25 million for 2020 and 2021.
• Income Tax Expense has dropped from $81 million in 2017 to $12.7 million in 2019. We expect income tax to be $5 million in 2020, and with the company set to turn profitable in 2021, we expect the effective tax rate to be around 14.3% for 2021.

Per Trefis estimates, Cree’s EPS for fiscal 2021 is likely to be $1.94. Taken together with a P/E of 27.5x, this works out to a fair value of $53.40 for Cree, which is roughly 3% ahead of the current market price.

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