Wednesday January 30, 2013
by Paul McWilliams, editor Next Inning
Cree (CREE) easily topped the consensus estimates for calendar Q4 2012; the trend is clearly positive and supportive of my broader thesis.
Beyond the obviously accelerating adoption of LED lighting being favorable for CREE, we saw solid evidence that higher LED sales were driving more efficient utilization of fixed cost resources and, therefore, resulting in higher gross profit margins.
I believe it will continue to benefit CREE in calendar Q1 and going forward from that.
Power discrete components, which CREE builds using its Silicon Carbide (SiC) technology, carried a non-GAAP gross margin for the quarter of 56.6%, representing 6.5% of total quarterly revenue versus 6.4% in calendar Q3 and only 4.7% of revenue in calendar Q4 2011.
While still a small percentage of CREE's total revenue, power SiC discrete semiconductors remain a very intriguing part of the larger CREE story. CREE has furthered its development here and now offers some very compelling solutions for high voltage/high power markets.
The high voltage/high power markets are growing rapidly with the further deployment of alternate energy technologies, and while design cycles are long, represent a very exciting market for CREE going forward.
I suspect we'll see CREE continue to show good growth here, with a good potential for strong acceleration beginning with fiscal 2015 (long design cycles are the issue here).
Given CREE's growth potential, and the very good chance that it could again become a Wall Street darling, I think there is a reasonable chance we'll see the stock awarded a higher valuation multiple this year (higher than 18) - particularly if CREE continues to outperform Wall Street projections, which I think will be the case.
What's difficult today to ascertain is how far investors are looking out in their valuation assumptions - when viewing what they think is a compelling story, investors can look well beyond the normal year to 18 month horizon.
The hopefully not so subtle implication here is there's a high likelihood that CREE's already high volatility will move even higher. So, with that, let's model for upside from my intentionally conservatively slanted model.
If we start with my model of $2.00 (my fiscal 2014 earnings estimate) times 18 (the high side of my valuation multiple range) plus CREE's $9.36 in net current asset value, it drives a price of objective of $45.36.
If we increase the valuation multiple from 18 to 22, I don't think its unreasonable to project that CREE could trade as high as the mid-$50s in an optimistic market. And, given CREE's growth potential, I wouldn't view the stock as unreasonably over-valued at that price (at that multiple).
If we model the downside and assume no negative change in the outlook for CREE, but take into consideration normal CREE volatility and the risk of a modest market correction, I think we should give the stock room to dip to the mid-$30s.
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