During the first quarter of 2014, Cree (CREE) posted revenue growth of 24% year over year, while its LED product revenue (58% of the total revenue in fiscal year 2013) grew 16% year over year and lighting segment revenue (36% of total revenue in fiscal year 2013) grew 37% year over year. This robust growth in lighting products was because of increased demand of LED lights, on account of higher adoption of LED lamps. Although the penetration of LED in the overall lighting industry is quite low, with 2.8% share in overall lamp shipments expected in 2013, I believe this will increase in the coming years due to the surge in demand. Packaged LED lamp shipments are expected to grow from 520 million units in 2013 to 2.4 billion units in 2016. Though, there are substitutes available on the lighting market, but due to the various advantages of LED bulbs over the traditional bulbs, it is expected that there will be strong demand in the coming years. LED bulbs were earlier considered a luxury lighting product due to its high prices, but over time, the prices have reduced thereby attracting more consumers. Thus, availability of more energy efficient and longer lifespan LED bulbs has resulted in a rise in demand for these bulbs.
Cree entered the LED bulb market with launch of its under $10 priced product in March this year. This product had brightness comparable to incandescent bulbs and saved 84% of the energy compared to traditional bulbs. At the time of launch, this product was among the cheapest available LED bulbs in its electricity consumption category. Taking into account lifespan and energy savings of an average LED bulb, this price range was certainly an important catalyst for strong demand for these bulbs. Priced at $9.97, Cree's LED bulb provides light equivalent to a 40W, incandescent bulb, with power consumption of only 6W. Breaking the $10 price barrier was an important achievement in the lighting industry, providing LED bulbs at more affordable prices. Cree achieved this milestone with its vertically integrated manufacturing process, which resulted in operational efficiencies.
To provide further price reduction, Cree registered its two LED bulbs with the U.S. Environment Protection Agency for Energy Star rating. Announced in October this year, this certification allows rebates up to $5 for the purchase of a certified product. Some utilities give this rebate, and therefore Cree's 6W LED bulb will now cost at $4.97 compared to the earlier price of $9.97. While its 9.5W LED bulb, which replaces a 60W incandescent bulb, will now cost $7.97 a piece from an earlier price of $12.97. This reduction will increase the company's sales because of availability of lower priced LED bulbs, thereby positioning the company to benefit from the strong market demand.
Competitive environment may affect the margin
LED lighting is at a nascent stage and with gradual price reduction, and this market is expected to grow from increased user application. LED use has witnessed an increase in application to a variety of products from the traditional usage in LCD TV panels to lighting products, laptop and notebook display panels, automotive, etc. This has been an important growth driver for Cree, which manufacturers both LED chip, an important part for LED, and LED lighting products.
Cree operates in a tough competitive environment with companies like Philips (PHG) and General Electric (GE). Both the conglomerates are much bigger than Cree in terms of revenue and each is a threat to the company's market share in LED lighting.
Like Cree, Philips is a vertically integrated LED lighting product manufacturer, so Philips has been able to reduce the price of its LED bulbs to gain market share in the LED lighting market. Philips is the world leader in lighting and LED innovation, and due to its market leadership, the company is well positioned to capitalize on the LED lighting market opportunity. During its third quarter earnings in 2013, the company reported modest growth of 3% year over year in its lighting segment sales. Though the overall lighting product sales grew at a modest rate, LED product based sales posted a strong growth of 33% year over year. In October, the company signed memorandum of understanding with Dubai Municipality to support a transformation of the municipality's 262 buildings from conventional lighting infrastructure to an energy efficient LED-based solution. In addition to this, Philips was also selected by the Government of the City of Buenos Aires to renew its streetlights with LED technology. Announced in October this year, this contract involves replacing 91,000 streetlights out of the 125,000 streetlights in the city with new connected LED lighting systems over a three-year term. I believe Philips is the toughest competitor for Cree, as the company has already established leadership in the LED market, which has helped it gain government contracts for LED lighting replacement.
Another major player in LED lighting segment is General Electric. The company partnered with Wal-Mart (WMT) to provide LED lamps with a price tag under $10. Wal-Mart launched the LED lamps with its own brand, Great Value, LED lights. These lamps have been made in collaboration with GE, and I believe that this will start a whole new price war. In addition to its own brand, Wal-Mart will also be selling GE's own under $11 LED light bulbs, which are 60W replacement equivalent. This is $2 lower than the Cree's LED 60W replacement bulb available at Home Depot (HD). GE's partnership with Walmart will be important for expanding GE's presence in the LED market. Both the companies can afford a decline in the margins due to strong financials, therefore offering a price advantage over others.
This competitive environment may put pressure on LED lighting manufacturers' margins due to the reduction in prices, but Cree can leverage its vertically integrated process to provide a price advantageous product without much effect on margin. During its first quarter of 2014, the company reported gross margin increase of 1.1% quarter over quarter to 38.6%. Cree's entry into the consumer market with launch of its own branded LED bulb is an important move that will cater to the growing demand for LED lamps.
Conclusion:
Entry into the consumer segment with the launch of its first LED bulbs will help Cree capitalize on the market demand growth. Cree's low price bulbs will attract more customers for replacing their traditional incandescent bulbs with LED products. In addition, the company has a vertically integrated business model, which will not only help it lower the cost of LED bulbs, but it will also position the company to capitalize on overall market growth of LED applications apart from lighting products.
Cree also stands positive with respect to the valuation metric; the company has a trailing 12 months P/E of 65.62, while its' forward P/E for the year ending June 30, 2015 is 25.13. This difference in P/E denotes that the company's earnings will grow in the next fiscal year due to its topline growth and better margins. Therefore, I recommend buying this stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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