When LED lighting specialist Cree (Nasdaq: CREE) closed the books on fiscal year 2010, management promised only slightly higher sales in the coming quarter and the stock took a tumble on the news. At the time, the fall seemed to make no sense because the company is busy building out its manufacturing capacity in expectations of strong demand coming down the pipe.
As it turns out, that rosy view of the LED-lit future may have been a bit too optimistic.
First quarter sales landed at $268 million, a smidgen below that seemingly pessimistic next-quarter outlook but technically an improvement on the order of 1.5%. Earnings more than doubled from the year-ago quarter to $0.53 per share, which sounds impressive until you remember that the previous quarter saw quadrupled earnings year over year.
Cree is executing to plan, spending two-thirds of its operating cash flow on capital improvements such as a new manufacturing facility in Research Triangle, N.C. CEO Chuck Swoboda claims that demand for LED lighting "continues to gain momentum" and that slow sales was caused by "a decline in LED chips." But I think we've seen this movie before, only with different actors. The happy ending could be years away.
A veritable Greek chorus of analysts lowered their ratings on Cree after this report, and they all seem to agree that we're looking at an oversupply situation that puts pressure on selling prices, margins, and total sales. It's a little tricky to get a real read on this market because Cree's biggest competitors are multinational conglomerates Philips (NYSE: PHG), General Electric (NYSE: GE), and Siemens (NYSE: SI), none of which are likely to break out the business impact of LED lighting in their financial reports. The market just ain't big enough for anybody to care much about it. But for Cree, LED lights are everything. When the other players build out their LED manufacturing lines, this is the stock that suffers from the resulting price wars.
This is what happened to memory chip producer Micron Technology (NYSE: MU) a couple of years ago when that entire industry launched new factories far above what the market really needed, thus triggering a brutal price war. Toshiba and Samsung would always be OK regardless, as their other operations could absorb the damage from a crummy memory market. Micron's stock, on the other hand, was taken behind the woodshed for a thorough beating that it took years to recover from. Many smaller memory specialists with less impressive balance sheets went under altogether or were swept up by a wave of industry-wide consolidation.
Did Cree, Philips, and the other LED guys pay attention to that debacle? If they did, we should see product prices stabilize and capital investments in lighting factories subsume over the next couple of quarters. If not, things could get really ugly for Cree.
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Fool contributor Anders Bylund holds no position in any of the companies discussed here. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.
