Will Cree Bounce Back After a Bad Quarter?

Light-emitting diode manufacturer Cree (NAS: CREE) saw its shares go down 7% in extended trading after the company failed to meet consensus estimates in the second quarter. A depressing guidance for the current quarter compounded Cree's problems as the company struggles with shrinking margins in the midst of an oversupply in the LED market.

I will now put the company under the microscope and see whether it could be of any good in the long run.

A look at the quarter
Revenue in the quarter rose 18% to $304 million from the year-ago period but fell short of analyst estimates of $310 million. In the first quarter, Cree had acquired consumer lighting company Ruud Lighting. This deal drove the revenue curve north, as its LED lighting business grew tremendously. However, Cree saw sales of its LED products (which form almost two-third of its revenue), including backlit LEDs, decline $3 million from last year because of increasing competition from Chinese companies.

Cree's rivals from China are doing what they are best at: manufacturing at dirt cheap prices and then inundating the market with such products. The flood of LED products in the market led to a massive decline of 45% in prices of backlit LEDs last year and throttled Cree's gross margin to 35% in the quarter from 47% a year ago. The challenging scenario in the market has indeed hurt the company, but it is making an effort to fix its margins. A closer look will help us know why.

Getting cost effective
The first thing that a company needs to do in the wake of an industry oversupply is to install more competitive cost structure. And Cree seems to be doing just that by streamlining its inventory according to the demand-supply situation and innovating new components that are more cost effective.

Though management says its cost reduction program is bearing fruit, but unfortunately the gains are counterbalanced by declining prices of backlit LEDs. However, the good thing is that the LED lighting market is expected to grow in double digits over the next two years as the technology finds more takers in emerging markets. This will probably help the company counter the weaknesses in the LED backlighting business and help strengthen Cree's margins.

Lighting the way forward
Apart from cost reduction moves, Cree is doing well to penetrate the LED lighting market. The company's business in the consumer lighting space increased a massive 85% to $96 million and helped it stay in the green. Cree's latest acquisition has greased its wheels to tap this emerging business, and will hopefully get bigger as LED lighting finds more adoption among consumers and businesses.

The Foolish bottom line
The prevailing conditions in the industry are hurting Cree's prospects despite its positive moves, at least in the short term. The company holds promise and can turn out to be a long-term investment. However, it would make sense to wait till the industry consolidates and prices stabilize.

Till then, you can keep an eye on Cree by adding it to My Watchlist by clicking here.

At the time thisarticle was published Fool contributor Harsh Chauhan owns none of the stocks mentioned in the article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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