Cree Needs Revenue Growth To Spur Stock

Cree (NASDAQ: CREE) makes electronics devices -- getting most of its revenue from so-called Light Emitting Diodes (LED) and power chips. And after reporting better-than-expected fiscal fourth quarter results, things are looking up. But should Cree stock be in your portfolio?

Cree's sales and profits are shrinking but less than expected -- boosting the stock 9% after-hours. One could argue that Cree did everything wrong -- its earnings and sales fell while its expenses climbed. Specifically its earnings were down 63%, revenues fell 8%, and expenses were up quarter earnings sank 63 percent as demand for its products declined and expenses climbed 16% to almost $73 million.

But earnings per share and sales for the company were better than expected. Its adjusted earnings of 28 cents a share were two cents higher than analysts polled by FactSet expected. And its $243 million in revenues were 5% ahead of their expectations.

So should you buy Cree stock despite the declining financial performance? Here are two reasons to consider it:

• Cheap. Cree's price to earnings to growth of 0.50 (where a PEG of 1.0 is considered fairly priced) means it is very inexpensive. It currently has a P/E of 20 and is expected to grow 40% to $1.80 in 2013.
• Rising sales and profits and stronger balance sheet. Cree has been grown revenues and profits. Its $867 million in revenues risen at a compound annual growth rate of 19.7% over the last five years while its net income of $205 million has increased at a compound annual growth rate of 16.3% over the last five years -- yielding a wide 24% net margin. It has no debt and its cash has risen at 44% annual rate from $256 million (2006) to $1.1 billion (2010).

Two reasons to pause:

• Expectations-missing earnings reports. Cree has missed analysts’ expectations in two of the last five reporting periods -- and did so by wide margins in those quarters.
• Cree is under-earning its cost of capital -- and getting worse. Cree is earning less than its cost of capital – and it’s in decline. How so? It produced negative EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In fiscal 2011, Cree’s EVA momentum was -4%, based 2010 revenue of $867 million, and EVA that fell from negative $103 million in 2010 to negative $138 million in 2011, using a 12% weighted average cost of capital.

Despite its wide margins and growing cash, this company needs to resume revenue growth and out-earn its costs of capital before it looks like a stock worth buying.