It's lights out for the incandescent light bulb. According to the 2007 Energy Independence and Security Act, it is no longer legal to manufacture or import 40-watt and 60-watt incandescent bulbs in the U.S.
With that, the last bastion of the incandescent bulb has been knocked down; the 100-watt and 75-watt versions were phased out in 2012 and 2013, respectively. And at the same time, this ban points us toward the future of lighting, where companies such as Cree (NASDAQ:CREE), General Electric (NYSE:GE), and Koninklijke Philips (NYSE:PHG) are looking to make a big splash through their LED offerings.
LED lighting has seen rapid adoption in the past three years. According to Strategies Unlimited, LED lighting component sales grew an impressive 44% in 2011 from 2010. The industry is not expected to run out of steam any time soon. According to McKinsey & Company, the global LED market is expected to grow at a compound annual growth rate of 33% through 2016. By the end of the decade, the market is expected to be worth $94 billion. Thus, LED players such as Cree, GE, and Philips would be looking to make the most out of this opportunity.
However, both GE and Philips are diversified companies with interest in different areas. In comparison, Cree is a pure-play LED company, which is why it is a more aggressive way to play LED growth. This was probably the reason why Cree saw terrific growth in 2013. Its shares gained close to 90% in the calendar year, although there was some weakness toward the end as Cree's outlook for the just-concluded second quarter wasn't up to expectations.
But, as pointed out in a previous article, Cree's outlook took a beating because the company decided to spend aggressively on advertising. Cree needs to spread awareness about its products and this is why aggressive marketing is needed. The company is doing its best on the innovation front and continually brings new products to market. For example, it was the first company to break the $10 barrier by introducing the 40-watt replacement bulb for $9.97 last year.
Recently, the company expanded its portfolio by adding the 75-watt replacement bulb. Like its other products, this new bulb is expected to last 25 times longer but consume 82% less energy. In addition, Cree is making some impressive progress in commercial lighting. Cree's LED fixtures were chosen for a North Carolina State student-housing project when the university wanted to keep operational costs down. The company is further working on increasing the applications of its commercial lighting products.
For example, it recently expanded its street lighting portfolio by introducing a high-output version that can light up multi-lane freeways and expressways. Cree claims that this light will use less energy than the conventional 400-watt, high-pressure sodium lights and lower the cost of ownership. Moreover, Cree is offering a 10-year limited warranty, which gives customers peace of mind and more reasons to buy.
Also, Cree's bulbs are Energy Star certified by the Department of Energy, which means that they are eligible for instant utility rebates. This should further spur adoption of Cree's bulbs. Cree CEO Charles Swoboda says this will allow consumers to buy a Cree LED bulb for less than $5.
However, there are a few points that investors need to keep in mind. First, the LED lighting industry is a commoditized one, and the presence of bigger players with greater scale might lead to a price war. Next, companies such as General Electric and Philips have more resources at their disposal, so they can quickly scale up their production according to requirements and out-muscle Cree. At 73 times earnings, this makes Cree a pretty risky bet.
However, Cree's execution has been pretty solid so far, and the superiority of its products gives it an upper hand over competitors. For example, according to CNET, "Cree's 60-watt replacement LED is the bulb to beat." The Cree bulb beat Philips' SlimStyle LED on most counts such as power consumption, output, yearly operational cost, and warranty.
However, Philips has managed to price its 60-watt replacement bulb at $9.97, while Cree's offering is priced at $12.97. But considering the other advantages -- like the 10-year warranty that Cree offers, as compared to Philips' three years -- customers might swing in Cree's favor. Moreover, Cree's competitive pricing can help it further. The company's 60-watt replacement is priced way below General Electric's offering.
GE's 60-watt replacement bulb costs double that of Cree's LED bulb on Amazon.com. It consumes more power than the Cree bulb and has a higher yearly energy cost of $1.32 based on three hours of usage per day. Also, the General Electric bulb is expected to last for 15,000 hours, while Cree claims a life of 25,000 hours. This is why Cree's specialization in LED lighting is an advantage as it can make its products more sensible buys when compared to the competition.
The bottom line
Cree has delivered solid growth in the past. In the previous quarter, the company had delivered 90% year-over-year growth in earnings and 24% growth in revenue. Considering the opportunity present in the LED lighting industry, along with Cree's innovative and well-executed products, investors can expect such momentum to continue going forward.
However, there might be sharp fluctuations, since Cree is valued expensively as it is expected to grow its earnings at a rapid pace. Even a small hiccup, like the one we saw toward the close of 2013, could send shares lower. But the long-term opportunity looks good.