Cree (CREE): LEDs for the 'green revolution'

by Geoffrey Seiler, editor BullMarket.com

Cree (CREE) is a leading provider of light-emitting diodes (LED) and related technology.

In my view, the company is in an excellent position to benefit from the "Green Revolution" taking place in the lighting industry.

Operationally, the Durham, North Carolina-based company delivered solid results for the quarter ended June 27th, which was its fiscal fourth quarter of 2010.

The company announced last night that it earned $52.8 million, or 48 cents per share, up from $9.7 million, or 18 cents per share, in the year-ago period.

For the full year, the company earned $152.3 million, or $1.45 per share, up from $30.3 million, or 34 cents per share, in fiscal 2009. Sales grew by 53% to $867.3 million.

Cree's stock price was crushed, following this report. The negative reaction to what looks like solid operational results was due to the company's guidance.

Management said it expects to generate Q1 sales of $270 million to $280 million, as growth in LED lighting-related products will be partly offset by softer LED chip demand for consumer backlighting applications.

The sales forecast was below the analyst consensus of $284 million, though adjusted EPS of 56-59 cents per share was ahead of the EPS consensus of 54 cents.

Management, not surprisingly, thinks it wrapped up a pretty good year and that the outlook for the LED industry is bright.

Analyst reaction to results and outlook was mixed, which is in line with what is a mixed to moderately bullish view of Cree on Wall Street.

Of the 26 analysts that follow the company, there are 15 "buy" or "strong buy" ratings, but also seven "holds," three "underperforms" and one outright "sell" according to Thomson One Analytics.

Those analysts that have a positive view of the stock generally think the sell-off creates a potential entry point.

We believe LED lighting is the green technology that will continue to be at the forefront of the green revolution.

While wind, solar, and ethanol have gotten the headlines, LED has quickly become a practical, non-toxic and profitable alternative to less-efficient standard light bulbs.

Home Depot has introduced its own line of LED products it has branded Ecosmart. Those products were not on the market a year ago and could provide a huge boost to the industry.

The capacity constraints in power and RF segments is a bit of a headwind for the next couple of quarters and does open the company up to the potential of losing share to competitors, though it is worth remember that segment is the smallest part of Cree's business.

The balance sheet is in excellent shape, with a growing cash pile and no debt.

As with most high-growth stocks, Cree isn't cheap on a P/E basis, now trading at about 26x current year estimates.

However, if the stock can grow its earnings at a 35% clip, its EPS in 2014 would be about $5.65. Put an 18x multiple on that and add back just its current cash ($9.76 per share), and you have a $110+ stock in a few years.

Of course, Cree would have to execute and the macroenvironment cooperate to reach that EPS target, and it's worth noting that a 35% growth rate is well above the current consensus growth rate at present.

We think that type of growth rate is achievable, but not a guarantee. But even at only 20% earnings growth, we'd still see a $80+ stock in a few years.

While best suited for more aggressive investors, we're going to add Cree to our Recommended List with a "Buy" rating and $80 target, which is a 25x multiple on 2012 EPS estimates (which we believe are low) plus adding back its cash.

As always, we recommend establishing a starter position and then dollar cost averaging in on weakness.

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