Cree: Caught in a Flickering Industry

In addition to being small, light-emitting diodes (LEDs) consume a fraction of the power of more traditional lighting. Core applications include backlighting for mobile phones, signage and indicator lights while those on the horizon include backlighting for notebook computers, TVs and general lighting.

Semiconductor manufacturer Cree's (CREE - commentary - Cramer's Take) LED chips have gotten brighter while dropping in cost, opening new markets over the last few years. However, the underlying environment appears to be challenging for LEDs in general, which spells pricing and margin pressure for Cree near term. While I like the nature of LEDs as a replacement technology over the long term, it's hard to get behind given the current industry dynamic.

Recent data from Cree's competitors suggest weakening demand for LEDs in the last two months of 2008 due to the global economic downturn and its effect on consumer electronics demand.

• Taiwan-based LED packaging company Lite-On Technology announced November consolidated revenues were down 23% compared with October.
• LED packaging company Harvatek reported November revenues that were down 31.6% from October. Harvatek's LED shipments in November dropped to 120 million units from 220 million units in October amid a downturn in demand.
• LED packaging house Bright LED Electronics posted November revenues 25.6%.
• Unity Opto Technology's November revenues were down 17.6% from October.
• LED packaging company Everlight Electronics had November revenues down 21.5% from October and commented at the time it expected further sequential revenue declines in December owing to its weak order volume.

One of the better peer comparisons to Cree is LED chipmaker Epistar, which posted a 28.3% monthly drop in revenues in November and a 36.4% fall year over year. The LED business weakened further in December, down 38%, and the management team expects further revenue declines in the current month.

Key here is that Epistar's utilization rate dropped to 50% to 60% in November and fell a further 30% to 40% in December. Historically, low utilization levels have resulted in aggressive pricing in the LED industry in order to win share and keep production lines running. Such aggressive pricing spells bad news for gross margin trends near term.

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At the time of publication, Versace had no positions in the stocks mentioned, although positions may change at any time.

Chris Versace is a founder and managing partner of Agile Capital Management in the Washington, D.C., area. ACM uses a thematic perspective coupled with an ecosystem lens based on the methodologies that Versace used during his 13 years as an equity analyst at Salomon Brothers, Donaldson, Lufkin & Jenrette and Friedman Billings Ramsey.

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