Pacific Crest Favors Veeco Over Cree In LED Sector

Pacific Crest analysts Daniel Baksht and Weston Twigg favor Veeco Instruments Inc. (NASDAQ: VECO) over Cree, Inc. (NASDAQ: CREE) in the LED sector. Both analysts believe they are "on the cusp of a positive inflection in the lighting industry." The two analysts also feel both companies have benefited and will continue to benefit from the current LED lighting adoption pace. However, the stocks were rated differently by these analysts in their initiation.

While the brokerage has initiated an Overweight rating on Veeco with a price target of $23, it initiated a Sector Weight rating on Cree shares with a price objective of $24. Although they pointed out that investor sentiments remained negative for both stocks since they trade near the multiples, the two analysts have high conviction of a rebound in demand by next year.

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Early Stages Of Adoption

The two analysts believe the LED lighting market is in the early stages of adoption. Therefore, they expect a positive inflection for four reasons. The first reason is that LED prices and efficiency are likely to improve each year, followed by LEDs enabling smart lighting, which the analysts view as potentially boosting the long-term payback of LED lighting. The third reason is that traditional lighting sales are on the decline, while the biggest companies are growing their LED lighting sales. The fourth and final reason is that “LED lighting in North America has penetrated, in our view, just ~5 percent of the installed base.”

Therefore, Pacific Crest analysts expect the LED lighting market to grow more rapidly than the LED chip market. The analysts elaborated, “We believe the global LED lighting market will grow to $39 billion by 2019, up from $21 billion, with companies differentiating themselves based on product, brand and sales and distribution channels.

“We believe the LED chips and components market will grow more slowly, up to an estimated $18.5 billion by 2019 from $17.0 billion, with companies competing for share based primarily on price and quality.”

Leader In Thin-Film Equipment

The advantage the analysts see Veeco has having over Cree is that the former is a “reader in thin-film equipment for LED chip manufacturers.” The company holds a leading market share of +75 percent in the production of front-end equipment for LED chips production. The analysts added, “We expect revenue to decline by 36 percent in 2016 and increase 32 percent in 2017 as demand for its equipment rebounds due to growth in LED lighting. We believe the risk/reward is attractive as VECO trades near trough multiples and at a discount to peers. Our price target is $23, or 1.2x 2017 EV/sales.”

On the other hand, Cree is focused on LED lighting in North America. The company is a “vertically integrated LED company,” with a focus on the downstream LED lighting segment in North America. Baksht and Twigg said, “We believe the North American lighting market could grow to $11 billion by 2019 from roughly $6 billion today, and Cree should benefit from this trend. We have concerns whether Cree can maintain its share of roughly 15% in the North American LED lighting market given increasing competitive threats. We see fair value around $24, which is 20x our C2017 EPS estimate.”

Cree closed Friday's trading down 0.18 percent at $22.43, while Veeco closed up 5.59 percent at $17.37.