THE HEDGEYE EDGE
Growth of Cree (CREE) demand for new uses of SiC are driving revenue and margin upside, while the slowly healing LED market is driving directional change in estimates. If Lighting execution improves it would be a night and day impact, all under the guidance of a new CEO with no magic bullet but a great history of getting it right. We suggest using weakness to accumulate shares with a view that P+L, margins, and FCF will trough in front of us but out-year will reflect ongoing growth + turnaround efforts. We see 25-30% downside risk and 50-75% upside risk on a 1-2 year basis at 25x FCF.
INTERMEDIATE TERM (TREND)
SiC is a breakthrough power conversion technology that is in the process of being adopted by more mainstream applications. Cree's position in that market, including substrate, epi, and devices, amounts to a ~$140-150m annualized run-rate in a $325m+ market that will grow 2-3x in the coming years. Over time, SiC applicability will continue to broaden. We recognize there is some excess hype in the category, and we don't see $500 worth of SiC adopted into a car, more like $50 at real volumes. However, the breadth of adoption is widening, CREE's competitive position is strong, and there is a CEO in place who will also care about the bottom line and FCF.
The LED market is a tough place for CREE to operate but headwinds in the market have partially receded and the new CEO will have opportunity to better monetize the IP in this category as the industry shifts to intelligent lighting (IoT).
Furthermore, while we realize we are in a minority on this view, after several horrible years, there is finally a demand catalyst on the horizon for the overall LED industry (micro LED) that can help improve unit fundamentals starting likely in 2019. While that sounds like a long way off, it is the first time in years that there is a new long term demand driver for the industry.
The Lighting division's troubles are mostly from being locked out of the most lucrative channels, which is not set to change in the near term. But industry executives believe there would be potential suitors for the division, and management sees a path to margin improvement as they solve for some of the self inflicted wounds from the past few quarters. We think margin upside in Lighting is not priced into buyside expectations at this time.
LONG TERM (TAIL)
Net, we are excited about what (new CEO) Gregg Lowe can do with CREE. We admit the stock has had a good run, pushing the LTM EV/FCF calculation to less compelling levels with FCF set to go lower in the near term to fund SiC capex. Still, if we were on the buyside, we’d be buyers on red, looking to own this one for ~18 months duration to benefit from a 2x in SiC revenue, LED industry improvement, Lighting GM% changes, and the new CEO’s strategic direction.
ONE-YEAR TRAILING CHART
