Cree’s Stock Puts Its Bright Idea in the Shade

Cree’s Stock Puts Its Bright Idea in the Shade

DAN GALLAGHER

March 26, 2014 1:58 p.m. ET

If nothing else, Cree CREE -1.94% knows how to put all of its chips on the table.

Consider its move last year into selling LED light bulbs to consumers. For a semiconductor company accustomed to healthy margins, shifting to a segment selling mostly commodity products at thin margins seemed counterintuitive. The effect was predictable. Revenue in Cree’s lighting-product segment surged more than 40% year over year in the second fiscal quarter through December, while the gross margin for the segment slipped from 33.7% to 27.9%.

But for Cree, this isn’t about owning the market. Rather, it is a gamble to turn the company into a recognizable brand in LED lighting, which can be parlayed into the more-lucrative business of selling lighting systems for commercial buildings.

The potential payoff is great, but then so are the risks, especially in light of Cree’s history of volatility.

A mix of government incentives and a growing desire to reduce energy consumption has made LED bulbs attractive replacements for incandescent lighting. LED lighting uses less electricity and lasts longer, helping to offset its higher upfront cost.

Canaccord Genuity estimates about 367 million LED bulbs were sold globally in 2013, and that number could rise to 677 million this year at the midpoint of the broker’s projected range. Annual shipments are expected to top 1 billion units by 2015.

Cree’s efforts to woo consumers got a boost last year from its partnership with Home Depot,HD -0.76% which heavily promoted the company’s bulbs in its stores. Cree says the relationship strengthens its brand for better exposure to the commercial lighting market, where it can sell full systems at greater profits.

Cree’s big challenge, however, is that it isn’t entering virgin territory. It will take Cree time to develop this business, during which its aggressive pricing on consumer bulbs may put even more pressure on margins. The company announced earlier this month that it was lowering the price of its LED bulb line by as much as 23%. The commercial-lighting sector has many established incumbents, though, and competition is fierce. More than 50 other vendors are listed on Amazon.com AMZN -3.19% as selling similar 60-watt equivalent LED bulbs, some at below Cree’s listed prices.

And Cree’s investors could be forgiven for wanting a quieter life rather than more risk. In the past five years, the company’s stock has taken a stomach-lurching round trip from the low $20s to above $80 and back again. It saw spikes of more than 24% in the two-month periods before two quarterly reports last year only to erase those gains following the results, which included lower-than-anticipated revenue and disappointing forecasts.

With a 12-month stock gain of only 7.8%, Cree has underperformed the broader market and the tech sector by a notable margin. But that doesn’t make the stock cheap. It trades at about 30 times forward earnings, with an enterprise-value-to-forward-sales multiple of 3.2 times—which is a premium to other companies in the specialty lighting space, including Acuity Brands AYI -3.76% at 2.3 times.

Cree’s strategy of tempting an army of consumers as a way to snare more-profitable commercial customers is sound enough. But that doesn’t give the stock mass appeal.