Better Times Lie Ahead for This Growth Stock

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LED specialist Cree (NASDAQ: CREE  ) was down in the dumps in mid-August after it issued a relatively conservative outlook that did not satisfy Wall Street. The stock saw its share of downgrades and price target cuts after Cree's guidance missed analyst estimates.

Analysts were looking for earnings of $0.43 per share on $398.4 million in revenue. Because Cree guided for earnings between $0.36 and $0.41 per share on revenue of $380 million-$400 million, the stock lost a fifth of its market capitalization in a single day.

Bouncing back, handsomely
However, Cree shares have bounced back handsomely over the past month -- gaining an impressive 34% -- driven by an analyst upgrade and terrific results by fellow LED player Acuity Brands (NYSE: AYI  ) . Acuity's recently released fourth-quarter results show a 35% jump in net income and a 13% increase in revenue. 

Acuity's report turned out to be a glowing endorsement of the prospects of the LED lighting industry. Acuity said it is witnessing robust demand for residential lighting products on the back of new housing demand and renovations. Going forward, management expects demand to continue improving in fiscal 2014, and favorable order rates in September indicate the same. 

Bright prospects
Hence, Cree's sharp drop in August was nothing but a blip in an otherwise fantastic year where the stock has gained 120%. In addition, it also drives the point home that following analyst ratings is not always a good idea, as they can change at the drop of a hat. Instead, investors should focus on the prospects of the LED lighting industry and Cree's cutting-edge innovation.

Cree operates in a market that's expected to see annual growth rates of 34% till 2016 and then 13% till 2020. By 2020, the LED lighting market is expected to be worth $94 billion, according to McKinsey, and Cree looks well-positioned to tap this opportunity through its products.

Cree's 40-watt replacement LED light bulb, which costs $9.97, is priced below rival products such as those from General Electric. In addition, Cree's bulb is more efficient, delivering the same 450 lumens as GE's light but consuming 50% less electricity. In addition, Cree's recently launched XSPR Series Street Light that costs $99 is expected to make replacing sodium street lights cost-effective and 65% more energy-efficient. 

Preparing for a fight
However, Cree should brace for competition from the likes of Wal-Mart (NYSE: WMT  ) , which recently made an aggressive move into the LED light bulb market. Wal-Mart recently announced its "Great Value" range of LED bulbs that would retail for under $10 in all its stores in the U.S. and also Wal-Mart claims that these bulbs would be 80% more efficient, discharge 40% less heat, and will last 25 times longer than a traditional light bulb. 

Wal-Mart is a behemoth with thousands of stores in the U.S., and its move into selling LED bulbs for a competitive price could hurt Cree. However, Cree's bulbs sell at home-improvement retailer Home Depot, which has a footprint of 2,258 stores in 50 states. This partnership has proven fruitful so far, as evidenced by a 22% year-over-year jump in revenue in the previous quarter.

In addition, Cree has also earned the Energy Star qualification for its LED bulbs. This means that its bulbs now qualify for utility rebates through certain local utilities. This qualification and the accompanying rebate can further drive adoption of Cree's LED bulbs and help it compete against Wal-Mart's forthcoming challenge.

The bottom line
Cree has successfully grown its business in a market despite the presence of more illustrious players such as General Electric, Koninklijke Philips, OSRAM, etc. Cree's continuous focus on innovation has helped it gain lighting orders, and the company is also undertaking a series of cost-reduction programs to bolster its margins. 

Cree's P/E ratio of almost 100 is no doubt high. But, considering that earnings are expected to grow 34% this fiscal year (ending in June next year) and 31% in the following one, more upside could be in store for Cree.

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Related Tickers

9/30/2016 4:02 PM
AYI $264.60 Up +4.19 +1.61%
Acuity Brands CAPS Rating: ***
CREE $25.72 Up +0.39 +1.54%
Cree CAPS Rating: ****
WMT $72.12 Up +1.39 +1.97%
Wal-Mart Stores CAPS Rating: ***