BARRON'S ONLINE: Time To Flee Cree?
Weekday Trader
By Eric C. Fleming
Hey buddy, got a light?
Cree Inc. (CREE) has some fancy ones, but not the kind you smoke.
The company makes small light-emitting diodes (LEDs) that are used to illuminate cell phones, auto dashboards and traffic lights. Since Oct. 8,
Cree's stock has burned very bright, along with many tech stocks, more than doubling.
Buzz surrounding an anticipated migration to color cell phones was responsible for some of the recent run, opines Chris Versace, analyst at Friedman Billings Ramsey. Because color handsets require a longer battery life
and brighter lights than the monochrome variety, Cree's energy saving technology seems a natural fit.
But bulls may be ignoring some key points about Cree, like declining margins, stiffening competition, weakening end markets and lofty valuations.
"It's a finite and heavily contested market, with low-cost manufacturers in Taiwan and Japan," says Alex Gauna, analyst at UBS Warburg, who rates Cree Reduce.
On Dec. 11, Nokia Corp. (NOK), a Cree customer, cut its fourth-quarter sales
estimate. The world's largest handset maker said customers were eschewing handsets with color screens and cameras for cheaper models.
With half of Americans unwilling to pay more than $50 for a handset and battery-life gobbling color handsets priced at about $300, "we were a little skeptical about color handset growth," says Versace.
Cree LEDs are made of semiconductor materials that create blue or green light when an electrical current runs through it. The sturdy LEDs have greater longevity and are more power-efficient than conventional incandescent bulbs.
How efficient? A LED traffic light eats about 90% less power and can lasts 10 times as long than its incandescent equivalent. Of course, LEDs can cost up to $1, which can get expensive when used in a taillight, for example.
End demand for LEDs in cell phones and auto dashboard displays, which contributed 48% and 24% of fiscal first-quarter revenue, respectfully, is clearly vulnerable.
Auto makers like Ford Motor Co. (F) now offer loans with no interest for five years to spur sales. But if interest rates climb, that could hurt demand for cars and thereby reduce demand for the lights that go into the cars.
Cree's LEDs are also widely used in traffic lights and those monster screens, so common in places like New York's Times Square.
While it's one thing to have impressive technology, "it's another if [Cree] can make money at it over time," says Larry Tedeschi, analyst at Banc One Investment Advisors.
Cree declined to comment, citing its "quiet period."
Cree's competition is getting stronger, too.
Pricing pressure from Japanese rivals Nichia and Toyoda Gosei, in part, pulled gross margins down to 38.8% in the fiscal first quarter from 46% a year ago.
"[Cree has] plenty of competition, and they keep having to bring pricing down," says Tedeschi.
Nichia has 30% of the LED market, while Cree and Toyoda Gosei each have a 19% stake, according to UBS Warburg estimates. Taiwanese manufacturers make up the remainder.
Cree also depends on just a few customers for a lot of business. Osram Opto Semiconductors (the Infineon Technologies-Osram Sylvania LED-making joint
venture) and wireless equipment maker Spectrian comprised almost half of Cree's fiscal first-quarter sales.
Cree also makes wireless chip components for stations that receive and transmit wireless signals through its troubled Cree Microwave unit. The company purchased Cree Microwave from Spectrian Corp. (SPCT) two years ago for $113.5
million.
Spectrian is Cree Microwave's principal customer, accounting for 90% of its revenue since the purchase. But Spectrian has been cutting orders and Cree
Microwave's sales fell 93% in the fiscal first quarter. (The unit contributed
1% fiscal first quarter sales.)
"I don't think Cree Microwave is firing on any cylinders," says Nathan Churchill, analyst at Sidoti & Co, who rates Cree Neutral.
Cree Microwave has been shopping around for other customers, but competition is formidable. Motorola Inc. (MOT) is the dominant player in this space, along
with Infineon Technologies AG (IFX) and Philips Electronics (PHG).
"[The wireless infrastructure] market just evaporated," says Churchill. "Now everybody has a nationwide network and [Cree] will have a tough time finding customers."
Cellular communications providers, like AT&T Wireless Services Inc. (AWE), have been hit hard after a massive infrastructure buildup. Now, as its pool of
customers has stagnated, carriers are tightening belts.
On top of all this, Cree's valuation seems flat-out rich.
Cree shares trade at 8.7 times trailing 12-month sales and nearly three times its book value at $6.65 a share, well above rivals Philips and Motorola.
Shares of Cree trade at 59 times the consensus estimate for its fiscal 2003 - double its long-term annual earnings growth rate - and 33 times the fiscal 2004
consensus estimate of 62 cents.
The fiscal 2003, P/E is also higher than the stock's five-year median forward price/earnings multiple at 46.8 times, according to Thomson/Baseline.
Financially, the company seems sound. It is profitable, carries no debt and has more than $100 million, or $1.39 a share, in cash.
Of course, demand for cell phones and autos could improve when the economy turns around. And as LEDs get brighter and cheaper, they may find greater demand.
Considering Cree's weakening fundamentals and the stock's lofty valuation, potential investors may want to hold off buying until the company's outlook brightens.
(END) Dow Jones Newswires
12-16-02 2143ET |
