Cree (NASDAQ:CREE) makes LED light bulbs, and has been rather volatile over the last six months. However, strong quarterly performance has many buying into the idea of strong long-term performance. The big question now is whether investors should trust the company and invest in Cree, invest in suppliers like Rubicon Technology (NASDAQ:RBCN) and GT Advanced Technologies (NASDAQOTH:GTATQ), or avoid the space altogether?
A company plagued with inconsistencies
In the first six months of 2013 shares of Cree more than doubled following a series of fundamental indicators and initial sales reports that showed strong demand for its high-performance LED light-bulbs, which save consumers money long term.
Since then it has been an up-and-down story, as there is constant debate as to whether consumers are willing to pay high prices for LED bulbs to save money in the future.
With more than 50% of Cree's revenue created from LED sales, and nearly all of its 20% growth, Cree's stock is directly dependent on whether or not consumers are willing to buy these LED bulbs.
Cree showing strong fundamental improvements
With the story known, it's worth noting that Cree recently announced a rather impressive quarter.
Not only did the company beat on both the bottom and top line with sales of $415 million, but its gross margin from LED sales stabilized at 45.4% after seeing pressure in recent quarters.
Furthermore, after a fury of cautious outlooks from analysts, it appears that more research firms are starting to support Cree. Goldman recently said that guidance from Cree implies 30% plus company gross margin on a consistent basis – Cree's current gross margin sits at 38.2%. Lastly, Goldman thinks that Cree is well-positioned for a breakout in June as the summer months approach and housing construction boosts.
With that said, we still haven't answered the question of whether or not Cree is a good investment.
Is Cree a good investment?
Cree has always been rather transparent with its guidance, being fair and always willing to bring Wall Street expectations back down to earth. While Cree's current guidance for the upcoming quarter is solid, investors must be concerned if whether or not it is sustainable.
Specifically, investors must remain concerned about competition; just because LED lighting as an industry may thrive doesn't mean that Cree will. In fact, a six-pack of Cree bulbs can range between $55 and $75. Meanwhile, Wal-Mart sells its own LED bulbs for about $10.
Granted, Cree investors will say that its LED products are of higher quality, but the end result is that both save consumers money while one is many times cheaper. As a result, guidance is likely to remain volatile, as predicting the consumer's struggle with this buying dilemma might be impossible. However, this fact doesn't mean that LED lights as a whole is a bad industry; it just means that Cree could continue to struggle with pricing.
What about suppliers?
Rubicon is a LED wafer vender and GT Advanced a global equipment supplier in the solar, electronics, and LED industries. Then, there are others such as Veeco and Aixtron, but Rubicon and GT Advanced are both tied directly to the LED market and Cree.
If we look at both companies we would see that explosive growth is expected in 2014.
Of the 10 analysts covering Rubicon, the estimated revenue growth for 2014 is 68%, and with GT Advanced the consensus is 128% growth. The problem is that both company's carry very low operating margins of negative 32% and 54% for GT Advanced and Rubicon, respectively.
Unfortunately, for suppliers, poor margins seem to be a consistent. Yet, for the most part, these suppliers have performed very well, outperforming Cree as investors seek alternative ways to benefit from the LED demand.
However, given the poor margins, no proof of near-term improvements, and fear of dilution, it's hard to imagine either as a preferable investment over Cree. Lastly, while these suppliers rally in tandem with Cree, and performed well following Cree's earnings report, investors must be careful of what they are buying, and its connection to a specific industry.
While Rubicon is highly connected to the LED space, GT Advanced generates only a small percentage of its revenue from LED, less than 10%, as the majority of its sales come from solar. Thus, GT Advanced might not be a good play on LED lighting despite it rallying with strong fundamental performance for Cree and other LED manufacturers.
At 28 times next year's earnings, Cree is not particularly expensive given its 20% growth. Therefore, investors might find a lucrative opportunity in its stock.
The core problem with Cree lies in its lack of consistency, and the uncertainty surrounding the decision making process of consumers, which is something that no analyst or research report can accurately predict.
Hence, to invest in Cree you are taking a bet, one that carries a high amount of risk but could lead to very large gains. As of now, Goldman thinks the rest of the year will be strong, and if Cree can show one more quarter to prove this notion, the risk profile becomes much more attractive for longs.
Hence, be patient, but as of now, view Cree with a heavy amount of skepticism, that is until proven differently over a longer period of time.
Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.