Cree 10Q1 Earnings -- Another Great Confirmation

Cree (CREE) reported their FY2010 first quarter results last week and provided another strong confirmation that the long awaited market for white LEDs may in fact be approaching. The strong performance of the stock since then can be viewed as an indication that the impatient institutional investors, who have been waiting for more solid data that this market will in fact occur, have now started to believe it will.

The following table highlights the earnings results for Cree's FY2009 fourth quarter, ended Sept. 27, 2009.

Source: First Call

These are obviously good results, particularly since the extremely strong EPS surprise came on a small revenue surprise.  This indicates that margins were higher than analysts expected, which in turn implies that Cree is not experiencing any pricing pressure.

Cree also increased their guidance for the current FY10Q2 quarter.

As with last quarter, however, the results themselves became even more meaningful when combined with the comments made in the conference call about the evolution of the market for white LEDs.

For several years, Cree has been in what we called "a holding pattern," where investors felt they needed to wait for the arrival of a market for the commercial use of white LEDs.

Here is a summary of the points made during the conference call that all pointed to developments in the market for white LEDs.

• Components and chips both saw strong growth curves
• Commercial lighting and backlighting (use of LEDs in laptops and TVs) were the applications driving growth
• Lighting applications are now more than 50% of Cree's total revenue (meaning the end use of components and chips wind up in lighting products)
• Already seeing booking for Q3 delivery of products to be used in lighting products
• Samsung and Sharp have both announced strong commitments to deliver LED-based TVs in 2010, validating the use of LEDs in large video screens

All of these comments speak to the issue of the market for commercial lighting using LEDs as finally leaving the "premature" stage and entering the beginnings of a real growth phase.

Cree pointed to the outdoor municipal lighting market (parking garages, malls, etc) as continuing to be the largest driver. However, Cree also mentioned -- for the first time -- that the indoor market appears to be developing.

The replacement of existing  indoor lighting with LED-based lighting is the potential explosive growth market on which we have always based our long term investment premise. In the past, Cree has also stated that they could not see any real developments in that market, except for manufacturers experimenting with products.

Cree's statement that they are starting to see progress in this market is in sharp contrast to prior quarters, where they set expectations for indoor lighting products as in the distant future. The credibility Cree has earned in the past -- in lowering expectations -- now helps to build expectations for an eventual market for indoor LED market.

In addition, it is clear that analysts also believe that this market -- which we have always felt was inevitable and only a question of time -- is actually going to arrive.

The conference call contained strong evidence that Wall Street analysts also now believe this. The type of questions asked clearly illustrate the growing belief in the eventual arrival of the market.

In fact, some of the questions focused on how Cree will be able to handle the increased demand, since Cree has had a history (during the boom of demand for handset blue LEDs) of being unable to fulfill all of their orders. In addition, there was increased attention to Cree's progress with transferring their manufacturing capabilities to a 4" wafer line.

Even more astonishing, there were questions asked regarding Cree's belief that they might actually have difficulty purchasing additional chip manufacturing equipment, as there has apparently been backlogs in semiconductor equipment orders at some firms.

This was a very strong quarter, particularly in terms of justifying a faith that the widespread market for white LEDs in commercial lighting applications is finally developing.

We continue to recommend that investors following our long term investment premise for Cree continue to hold their positions, which we first opened at $19 per share six years ago.

We also feel that new investors not already invested in Cree, but wishing to participate in the potential market for white LEDs as a replacement for florescent lighting systems, can now do so, as many institutional investors appear to have done in the last few days.

Note: The author has a personal position in CREE, which was established and is maintained in accordance with Briefing.com's Trading Policy.

Cree (CREE): Oct. 30, 2009, close: $42.10, -0.98 (-2.27%)

Comments may be e-mailed to the author, Robert V. Green, at rvgreen@briefing.com

CREE is one of three stocks still remaining on our "Current Stocks" list, which are stocks we follow closely using a long term investment premise (three to five years). We added Cree to the Current Stock list on April 17, 2003, a full six years ago, at $19 per share.

Our long term premise was based upon the development of multiple new markets for Cree's core products, both silicon-carbide (SiC) and their LEDs based upon SiC and gallium-nitride. We stated at that time, five years ago, that we expected products to be developed for a variety of markets, including the following:

• Blue LEDs for use in handset display screens
• Blue LEDs for use in display screens of other types (TV and laptops) to allow wider range of colors (in combination with red and green LEDs.
• Blue lasers for use in applications such as CD and DVD readers (to create higher data capacities)
• SiC semiconductors for use in microwave applications (to exploit SiC's higher heat tolerance)
• White LEDs for use in commercial lighting, such as replacing florescent lights

None of these markets existed six years ago.

Some of the above markets did develop, such as the handset display market, but others failed to materialize, such as the microwave application market.

The handset market, in fact, was briefly extremely strong for Cree products and solid results drove the stock price to almost $40. However, since Cree occupied a position of premium quality and pricing, their presence in the handset display marketplace was quickly eroded.

Investors who viewed Cree as a vendor to the handset market decided that the company's growth curve was over. With little concrete evidence of any solution to this problem, those investors sold off their CREE positions.

That sent the price of Cree stock plummeting to the $20 level, almost where we opened the position.

Some investors argued that we should have closed the position in Cree at $40. We have always felt, however, that the biggest potential for Cree was the white LED marketplace and we argued for investors to continue holding the position.

While we would have preferred the emergence of the new markets to smoothly overlap the decline of a current market, we have never felt it prudent to close the position while "in-between" markets. It is simply too difficult to judge such transitions.

For that reason, we have advocated holding the Cree position since we first postulated it in April 2003 (at $19). In addition, we have urged increasing the position twice, in December 2006 (at $17) and in July 2006 (at $18).

For more on our long term investment premise for Cree, please see the Ahead of the Curve column of September 2, 2005 "Cree: Good Confirmation Of Long Term Premise."