UPDATE: Cowen Starts Cree (CREE) at Market Perform; Transition to Lighting System Vendor Will Take Time

(Updated - September 12, 2014 11:24 AM EDT)

Cowen initiated coverage on Cree (Nasdaq: CREE) with a Market Perform rating and a price target of $46.

Analyst Jeff Osborne commented: Cree is attempting to build the Cree brand through web based sales, television advertisements, and store end-cap displays at Home Depot and other retailers, which we estimate is crimping earnings by $0.05-$0.10 per quarter versus prior run rate spending levels. This is the impetus behind our below consensus estimate. We expect mid-single digit earnings growth in FY 2015 due not only to increased spending on marketing, but also because of a continued shift away from the high-40s gross margin semiconductor chips to lighting products, which have a gross margin in the high-20s. We forecast operating margins of 37.6% for this year and 36.6% for the following year. Over the longer term we expect to see margin expansion at the company as cost reductions play out and marketing spend normalizes; however, given the lack of full year guidance from management, it is unclear what their ultimate ambition is from a marketing perspective. Beyond lighting products and marketing spend, we see the greatest leverage playing out in the LED chip unit given improving global supply/ demand dynamics and rationale pricing. Currently, we model top line growth of 19% and 17% for 2014 and 2015, respectively.

Our checks suggest Cree’s lighting revenue is biased toward outdoor and the Home Depot bulb (11% of FY14 revenue) and the company has had sporadic success with its broadening commercial line-up. We are enthusiastic about the non-residential construction cycle in North America and see Acuity Brands as a better way of playing this trend given the breadth of products and more established agency sales force. We believe Cree’s current product lineup lends itself more to the sizable retrofit market for all three end markets – residential, commercial and outdoor versus new. It is important to note that the retrofit market typically caries 200-300 bp lower margins than new construction installs.

We see the shares of CREE as fairly valued at current levels. Our $46 price target represents a 25x-28x multiple on our fiscal 2015 estimate of $1.75. While the stock has historically traded well over 30x earnings when it was more aligned with LED chip sales, we believe the reduction in earnings growth to the mid-20% range suggests a PEG ratio of 1:1 is warranted and is more aligned with high growth industrial companies versus cutting edge semiconductor companies.

For an analyst ratings summary and ratings history on Cree click here. For more ratings news on Cree click here.

Cree closed at $43.24 yesterday.

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