Conclusion: buy this stock in the $30’s, benefit from the growth of a new technology penetrating into a large market, and also benefit from a major turnaround by an excellent manager. Harvest in the $60’s or own for the long term.
Three items in this note: Acuity read across (the part people missed), Major turning points, and our thesis on the stock
Acuity This, Acuity That:
Our view: less read-across
- Cree has been calling out weakness in US non-residential construction for a long time
- Overall lighting segment for Cree is ~40% of revenue, not 100%
- Cree is not exposed to Mexico/LatAm/UK the same way in lighting
Did you catch the bullish read-across?
- “we expect the price of certain LED components to continue to decline, though at a decelerating pace”
Remember that when we got involved with Cree our research data indicated that in Cree’s core LED chip category, price declines were already moderating. This idea is so contrarian in Cree. Since we went live with the stock a few months back most investors have been eager to remind us that Chinese capacity in core LED chips will continue to pressure LED chip pricing. It thus strikes as a material takeaway that Acuity is forecasting more in line with our data, which indicates that the negative ASP trends in chip lighting for IPR sensitive buyers has moderated. None of this absolves Cree from the long term pressure to think outside the box about the addressable opportunities ahead using their technology, but it does point to a core business being less bad in the near term than is commonly assumed.
Final read-across point: don’t forget that Cree guided the lighting business to be down -8% q/q, admittedly more shallow than Acuity’s printed -12% sequential but…Cree also hadn’t seen the upside to which Acuity had been exposed. That is not a bragging point, but Acuity is partially caught surprised with volume inflecting from +5% y/y to -1% y/y. Cree will not be surprised by softness. The obvious difference is in terms of supply chain inventory and preparedness.
Beyond Acuity:
We admit that CREE is an expensive stock on current metrics. As a result we understand that there will be moments of volatility that result as the market evaluates weakness and strength across the platform, and as the new CEO makes his presence felt.
Turnaround and Power electronics:
- What if the new CEO at Cree is creating a culture of winning? The more we read the more we understand how large the inflection is at Cree; taking a depressed company managed through fear (employees, partners, supply chain), and installing a culture of winning and success across the entire company. The inflection seems palpable notwithstanding the short period of time, and employees seem to be rallying behind the changes. Even the day one acts of selling the jets and removing the head of HR got our attention in a positive light. The swiftness of action shows in many respects that GLOWE landed at Cree with a plan at least partially already in hand.
- Power electronics. What happens when people realize that Cree will become an analog power electronics company with coveted technology that few can mimic? Have you applied for the power electronics design engineering job given all your DC-DC and AC-DC knowledge? Oh yeah, Cree is becoming an analog company. Didn’t you know? That’s the point. SiC is more than just substrate. It is everything from substrate to electronic device, and the applications reaching for SiC-based devices make the technology compelling as it penetrates and replaces parts of the much larger high voltage power conversion devices market. That market today is served by the you know who of analog, companies who sustain much higher long term margins and eventually fill up with cash flow. Cree is at the starting line with a compelling position in a technology manufactured mainly by three players.
More Details for the Curious:
Acuity reported revenue down 12% q/q and blamed US non-residential construction, as well as UK + Mexico + Latam that were down 35% y/y due to macro issues in those countries. Cree had previously called out weakness in US non-residential construction, and had already guided lighting revenue down 8% q/q. Was it worse for Cree? Maybe but they hadn’t see the upside that Acuity had experienced not that long ago.
Next Point: Acuity said they don’t see a reason to suspect a near term turn for the positive. Fair enough. The lighting business will continue to shrink for Cree, making it harder for the company to produce better profits while revenue is soft. Our view: let’s see where this goes. In other words, Cree lighting revenue already sucks. And most of the market assigns a $0 value (or negative) to the segment. Moreover, CEO Lowe just fired the two co-heads of the division in December, so we know things are going to change there. But I prefer the direction change with a new CEO trying to invigorate growth and efficiency, notwithstanding a softer market. In light of the low value already ascribed to Cree’s lighting business, other than calling for a complete collapse, it seems most of the risk profile is already strongly embedded here.
Bullish. Acuity also said that LED chip pricing will continue to decline but at a moderating pace: “we expect the price of certain LED components to continue to decline, though at a decelerating pace.” Is that bullish or super bullish for the core LED components? You can decide. Remember that when we got involved with Cree our research data indicated that in Cree’s core LED chip competitive category, price declines were already slowing considerably. This idea is so contrarian in Cree. Since we went live with the stock a few months back all we have heard is how China is killing Cree and that Cree doesn’t stand a chance and that Cree’s technology makes them out of whack on industry cost structure.
About the stock:
When we started down the path, CREE was a forgotten stock with tailwinds of a new CEO and a small but powerful growth segment.
The end game remains really bullish including fixing the mistake of vertical integration, building an analog high voltage business using SiC, finding niche LED markets with better long term price-to-value capture, using LED as a potential platform for SOC in IoT, greater efficiency from manufacturing to P+L to cash flow, and more rational capex cycles.
Here we are in the squishy middle. Gregg Lowe is turning the company from being run with a culture of fear to being a place to win and grow. There is an enormous inflection at hand. Traders tell me the chart has downside risks to $29-33. My response: ok, I am sanguine with that. Why? Because we are late in the overall technology cycle, positives are everywhere and everywhere embedded, but in CREE I have a chance to buy a company where the benefits of a disruptive technology and the benefits of a major turnaround in company growth, efficiency, and cash flow, are not reflected. Sure, the stock has moved a lot off the bottom, and maybe the first crack isn’t your immediate rush-to-buy signal, but buyers in the $30’s will make lots of money investing in CREE on the time horizons that matter.
