Wait for Cree to Blink

It's been about six months since I last discussed Cree (CREE), the light-emitting diode (LED) and lighting company, even though the shares have been on fire. During that time, Cree shares catapulted higher and recently peaked at $45.50 -- up some 60%, compared with 8% for the S&P 500 and 5.6% for the Nasdaq Composite. That's a home run for a company that's poised to benefit from exploding LED lighting demand as LEDs inch closer to crossing into the general illumination market. One of the key concerns with an industry that is undergoing a significant tipping point is the competitive landscape. We've seen this a few times over the last 10 to 15 years. Back in 2001, when mobile demand did not live up to expectations, many compound semiconductor player shifted gears toward LEDs. While that meant good things for the LED capital-equipment companies, it eventually led to a flood of supply that tanked LED industry pricing. More recently, LED initiatives in China spurred strong demand for LED capital equipment from the likes of Veeco (VECO) and Aixtron (AIXG) during 2010 and the first half of 2011. That push resulted in as many as 4,000 companies in China producing LEDs, and now, after three years of price competition that has slashed their revenue, these companies face a shakeup. We've seen that impact at SemiLEDs (LEDS), which has seen its share price fall from a peak near $30 in late 2010 to well below $1 a share currently. That shakeup is taking its toll on LED capital equipment demand and on the earnings and share prices of both Veeco and Aixtron. With the drop in demand, Veeco's earnings fell from just over $5 per share in 2011 to an expected $1.32 per share in 2012. I have to say expected, because late last week Veeco management announced that because of the company's ongoing accounting review, it cannot report revenue and earnings for the fourth quarter of 2012 just yet. Veeco did share that its orders rose quarter over quarter, but if its production levels were constant, that would mean its backlog exited 2012 in a range of $185 million to $195 million. That equates to roughly one and a half quarters of production -- far below what the company enjoyed back in 2010-2011. We'll get Aixtron's demand figures when it reports its full 2012 results on Feb. 28. Weak capital-equipment demand and the elimination of LED players in China mean that the probability of improving LED pricing is good, and that has always been the key to Cree's margins, earnings and stock price. We've already seen that over the last few quarters: Cree's gross margin rose to 38.5% in the fourth quarter of 2012, up from 36.8% in the third quarter and 34.8% in the second quarter. That margin expansion and some short-covering were the drivers behind that explosive move in Cree shares over the last several months. The question is, what do we do at current levels? Yes, prospects for further margin improvement are in place, and the company has a ways to go to reach prior peak gross margins of 47%, last seen in 2010. It was at that point that Cree shares peaked near $82 and traded near 38x earnings, which is far above where the shares are trading today -- a mere 29x 2013 earnings expectations of $1.53. Since Cree shares have run far and fast, I'd look to put new money to work on a pullback below $40. Current shareholders should be smart investors and trim back positions, given the 60% run in the shares over the last six months.

Wait for Cree to Blink

The LED maker's shares are buyable on a pullback, and current holders should take profits.

Columnist Conversation

Latest AAP Podcast With Portillo's CEO!

This Weekend on Real Money

Webinar Thursday After the Close: Option Spread Trading

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.