Green Energy Losers: SemiLeds, Cree

(Cree and Semileds article updated with analyst commentary from Morgan Stanley, Canaccord Genuity analysts.)

NEW YORK ( TheStreet) -- Shares of Taiwanese LED company Semileds ( LEDS) are down more than 17% early on Tuesday after its second straight earnings miss and an outlook about LED market pricing and margins that remains weak and implies a miss next quarter as well.

It's the second straight quarter -- and the second earnings since the company went public -- that Semileds had posted an earnings disappointment. Shares are down 50% this year.

The LED market has been under intense pricing pressure due to an inventory glut, which has hit shares of LED bellwether Cree ( CREE) hard. Cree recently had to take down its revenue guidance for the upcoming quarter, stating that the inventory glut was taking longer to work through than the company had predicted.

While the businesses of Semileds and Cree are distinct, signs of pricing pressure and gross margin weakness in the LED market are a surface negative for the entire industry when reported by Semileds.

Cree was also down by Morgan Stanley on Tuesday morning to a sell.

Cree shares, which already fell to a new 52-week low last month with the revenue guide down, were down by 4% on Tuesday morning in early trading and reached near average daily trading volume within an hour of the market open.

Semileds revenue for the second quarter was $10 million and a loss of 5 cents per share. The consensus was for revenue of $11.5 million and earnings of 8 cents.

Several analysts who cover Cree suggested on Tuesday morning that while the Semileds miss is a negative for the entire LED space, it's much more specific to Semileds and its issues, and the Morgan Stanley downgrade was a bigger negative for Cree. However, this was not a unanimous position for Wall Street.

Morgan Stanley wrote on Tuesday, "recent misses have reset expectations, but not low enough, in our view."

Morgan Stanley argues that with Cree trading at 25x 2011 earnings, valuation is nearly twice the market multiple, and its forecast of only 4% EPS growth in 2011 and -5% in 2012 makes the multiple impossible to justify.

"We believe lower ASPs, lower gross margins, and lower market share will offset strong industry volume growth in LED lighting," Morgan Stanley concludes in lowering its fiscal 2012 estimate by 29%, 17% below consensus. Morgan Stanley has a $36 price target on Cree, implying 21% downside.

Morgan Stanley expects 25% pricing declines for Cree per year.

Ultimately, Morgan Stanley comes down on the side of believing in the secular LED growth story, but not believing that Cree can maintain its premium in a competitive marketplace, for these reasons:
  • More companies have the technology and IP to produce and sell lighting-class LEDs and are pricing aggressively, especially for higher-volume products.
  • Share loss is a headwind. LED adoption is happening: Morgan Stanley forecasts penetration rising from less than 4% today to 35% by 2015. Cree is the share leader at 30+%, but we expect its share to fall to 15% by 2015.
  • Negative earnings growth in F2012 on lower ASPs (down 23% p.a., we expect) and lower gross margins (42.5% in 2012e vs. 45.8% in 2011e and long-termguidance of mid-to-high 40s).
  • Unfavorable risk-reward. "While our bull case offers 65% upside, it requires margin assumptions that we view as low probability," Morgan Stanley writes in the downgrade.
  • Significant forecast uncertainty. With growth rates over 50% and rapid evolution, there is significant uncertainty in LED industry forecasts.
  • "We believe in LED lighting. Cree has excellent products, a history of execution, and over $1 billion in cash, but we cannot recommend the stock today as a way to play this secular growth theme," Morgan Stanley writes in the downgrade.

    **

    Jed Dorsheimer, analyst at Canaccord Genuity, wrote in an email to TheStreet, "CREE and LEDS are component companies and thus gross margins tend to drive valuation, in our opinion. Margins don't tend to bottom in the low 40% range, so CREE's guidance makes it difficult to get constructive with the lack of visibility. There is a strong correlation between CREE and LEDS, although due to CREE's size and tier one position, they tend to set price. Results from both companies suggest visibility has been reduced in the sector."

    "While we believe the long term market opportunity of LEDs has not changed, the quarter did not meet our expectations relative to revenue, EPS or gross margin due to the aggressive, competitive pricing environment and our decision to preserve our market share," Trung Doan, Chairman and CEO of SemiLEDs, stated in the earnings release.

    Semileds gross margin for the second quarter of fiscal 2011 was 23%, compared with 41% in the second quarter of fiscal 2010.

    SemiLEDs expects revenue in a range of $6 million to $7 million in the coming quarter, missing the Wall Street consensus of $14 million. The LED company expects another loss of 7 cents to 10 cents in the coming quarter, versus Street consensus at a 14 cent gain.

    -- Written by Eric Rosenbaum from New York.

    >To contact the writer of this article, click here: Eric Rosenbaum.

    >To follow the writer on Twitter, go to Eric Rosenbaum.

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