More Upside in Store for Cree

More Upside in Store for Cree

When light-emitting diode or LED maker, Acuity Brands posted estimate-topping results earlier this month, fellow LED player Cree also received a shot in the arm. Cree was upgraded to a "buy" by Canaccord Genuity, which cited that Cree's second-generation 60-watt bulb stands to benefit from a more efficient cost structure and higher margins. As such, the firm bumped up its price target from $65 to $80.

Positive signs
Acuity's bright performance further established the credentials of the LED lighting market. Acuity saw its net income jump an impressive 35%, driven by a 13% increase in revenue as demand for its LED products remained strong. In fact, Acuity management stated LED product sales doubled on a year-over-year basis.

In addition, Acuity expects robust demand for its LED products in the coming year. Demand for residential lighting products, as a result of housing demand and renovations, are aiding the company's growth. Acuity saw favorable ordering patterns last month and expects this trend to continue in fiscal 2014, although some amount of volatility is expected in certain sales channels and geographies.

Can Cree deliver?
This sets the stage for Cree to report a strong set of results for its fiscal first quarter this week. But investors would be looking for strong guidance. Even a slight miss on the outlook would probably trigger a huge sell off, as seen last time, when Cree shares fell more than 20% in a single day. Cree guided for revenue between $380 million and $400 million, while non-GAAP net income is expected between $0.36 and $0.41 per share.

However, there's a good possibility that Cree would be able to issue a stronger guidance this time.

First, Acuity Brands' positive commentary about the end market's prospects, and growing order rates, indicate that demand for LED solutions is strong. Second, Cree saw robust order rates in the previous quarter. The company's backlog for the September quarter was better than the preceding one. Considering that Cree announced a strong order backlog halfway through its quarter, it can be expected that this backlog grew.

Next, according to Canaccord Genuity analyst Jonathan Dorsheimer, Cree's bulbs have been selling for $7.97 at Home Depot in New Jersey. Now, since Cree's bulbs have attained the Energy Star qualification, Dorsheimer believes that they will find more traction as utility companies in the U.S. buy more of its bulbs. The Energy Star certification allows "Cree LED bulbs to be purchased with an instant utility rebate, delivering consumers a quality LED bulb for under $5," according to Cree CEO Charles Swoboda.

Also, Cree is focused on growing its margins. The company expects production efficiencies to bring down costs, while higher LED fixture revenue is expected to contribute to margin growth. Management claims Cree has made progress in its margin expansion initiative, and incremental gains are expected in the ongoing fiscal year.

Cree is not the only one in the LED market to expect growth in gross margin. Even Acuity Brands expects an improvement in its gross margin on the back of higher volumes and manufacturing efficiencies. Hence, it is quite evident that players in this industry are singing the same tune as they expect volume growth -- on the back of higher demand -- to drive efficiency gains going forward.

A key partnership
Another factor that would aid Cree's growth is its partnership with home-improvement retailer Home Depot. With 2,258 stores across 50 states, Home Depot has a wide network. The most impressive fact is that Home Depot is seeing solid growth in same-store sales. In the last-reported second quarter, Home Depot's same-store-sales increased 11.4%. Moreover, Home Depot expects the ongoing quarter to be its strongest this year.

Home Depot has also introduced a 90-watt equivalent LED floodlight from Cree. This is good news for Cree. Moreover, the fact that its bulbs have received the Energy Star certification could lead to higher sales at Home Depot. Finally, Home Depot management believes "we are in the early stages of a housing recovery" and this suggests the company expects stronger store traffic going forward.

The bottom line
The stage is set and investors are expecting a solid outlook for Cree when it reports earnings. But, you should also be focused on the company's long-term prospects and not ignore the fact that Cree operates in a market where annual growth rates of 34% are expected till 2016, followed by 13% through 2020. McKinsey expects the market to be worth $94 billion by 2020, and Cree could be a good way to benefit from this growth.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Home Depot. 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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