Is Cree A Good Stock to Buy for the Long-Term?

The first time that I went caving, not so many years ago, I did so with a borrowed carbide lamp, a Rube Goldberg contraption that generates acetylene gas from calcium carbide and water.  Acetylene burns brightly and was the lighting method of choice for cavers and miners for decades after battery-powered lamps were available.  Incandescent lights chew up batteries rapidly and get dimmer and dimmer as the juice evaporates.

Cree, Inc. (NASDAQ:CREE)

These days, I have a couple of battery powered caving lights that use LEDs (light emitting diodes) instead of Thomas Edison’s old light bulb.  They burn a lot brighter for a lot longer.   LEDs are an improvement on incandescent bulb in both brightness and efficiency.    While LEDs cost more to produce, they save money in the long run as they are much more energy efficient.  They also put out less heat, not a big advantage in a cave, but in a building it saves money in air conditioning costs.  LEDs also last a long time.  Many of the low power LEDs produced in the 70s and 80s as indicator lights on electronic equipment are still in use.

So how come Edison’s old company, General Electric (NYSE:GE), is still selling light bulbs? The initial cost of high power LEDS has been a barrier to consumer acceptance. LED stocks like Cree (NASDAQ: CREE), Veeco Instruments (NASDAQ: VECO), Aixtron SE (AIXG) and Rubicon Technologies (RBCN) all did well during the 2010-2011 period when China was making a big push toward using LEDs to ease its chronic energy shortage, but have fell on hard times recently as China’s growth has slowed down and government subsidies for LEDs and equipment to produce them have declined.

LEDs are made out of semiconducting materials and like semiconductor chips, they have their own sort of Moore’s Law, only it is called Haitz’s Law.  Light output peer LED is rising exponentially such that it is doubling every 36 months.  This is due to continuing advances in semiconductor technology, optics and material sciences.   As LEDs get brighter, the uses to which they can be put also expand.  Besides their ubiquitous use as indicator lights, LEDs are now found in cell phone displays, traffic lights, car lights, LCD television displays, and architectural lighting, especially for the high end market.

But the killer app for LEDs is general illumination—replacing the incandescent bulb after its 100 year reign.  This is an annual worldwide market in the tens of billions.  Government regulations that require certain energy efficiencies in the U.S. and other countries are pushing the transition to LEDs.

Cree is more vertically integrated than other companies in that it not only makes the crystalline materials required for LEDs, like silicon carbide, and gallium nitride, but it also makes finished products for the ultimate consumer, which may be housewives, building companies, or government agencies.  The Marines, for instance, are already switching to LEDs.

Recently, Cree reported that due to increased efficiency, it was able to halve the number of LEDs used in street lights, lowering the cost to about the same as standard lighting.  But since the energy consumption is lower and the longevity higher, LED street lights have obvious advantages.   LEDs are generally last about 50,000 hours, which means that the street light could last a decade or more.   Ashville, North Carolina became one of the first cities to make the transition with over 3600 street lights, which are expected to save the city $260,000 per year.

Cree recently introduced LED down lighting that it claims will make fluorescence obsolete at current prices.  This gives the company entrée into the office lighting market.

In an age of global warming (Yes, Virginia, global warming has even reached the North Pole), switching to LED lighting allows companies to claim they are going green, an advertising plus, but now there is a bigger kicker.  It saves a lot of money.  Retrofitting may still be a hassle, but with any new building going up, it already makes perfect sense to go with LED lighting.

Cree’s stock price peaked at 80 in 2010 when the Chinese were gobbling up LEDs.  It has since crashed to around 24 and change, significantly underperforming the market.  Once burned in a given name, investors tend to shy away, at least until an uptrend is established.   Analysts expect the company to earn $0.92 per share this year, rising to $1.35 in 2013, a hefty 46% increase.    On the other hand, the company has a recent history of disappointing analysts, if by small amounts.

For me, Cree is one of those stocks that you buy and put away in the closet and look at it again after ten years.  The advantages of LED lighting over incandescent and even fluorescence are real and obvious and the businesses and governments will eventually realize the savings in cost and energy.   The switch has been slow, because the technology is being introduced into a world of slowing economies.  The upfront cost has been a problem, but those costs are dropping rapidly.  Cree is in the center of the LED transition and it’s a company that you need to own here. Columbus Circle Investors has the largest position in CREE among the nearly 400 hedge funds we are tracking. Columbus Circle initiated its position during the first quarter of this year. Kleinheinz Capital also got bullish about the stock recently, boosting its stake in CREE by nearly 200% over the first quarter.

CREE is expected to earn $1 per share in 2012 and it has $6 per share in cash. Excluding cash its forward PE multiple is a very attractive 17. General Electric, Cree’s diversified giant rival, has a 2012 forward PE multiple of 13, but its expected EPS growth rate is much lower than Cree’s. We think Cree is a much better investment than GE. Veco Instruments is also attractively priced considering its $14 per share cash position. The stock will make around $1.50 per share in 2012 but we should note that its earnings are very volatile. VECO’s forward PE ratio (excluding cash) is slightly more than 11. We like both VECO and CREE and recommend both stocks for investors who want to diversify their LED bets.

Note: This article is written by Steven Edwards.