Cree Stock Seems Overpriced After 2.5X Move

Cree stock (NASDAQ: CREE) is up around 2.5x since the beginning of 2020, and at the current price around $116 per share, we believe that Cree stock has over 25% potential downside.

Why is that? Our belief stems from the fact that Cree, a power and radio frequency product manufacturer, has seen its stock rise almost 4x from its low in March 2020, while the S&P has moved a little over 70% in comparison. Further, with demand struggling to rise to pre-Covid levels, we believe Cree stock could head lower. Our dashboard What Factors Drove 172% Change In Cree Stock Between 2018 And Now? provides the key numbers behind our thinking, and we explain more below.

Cree’s price rise since 2018 came despite a 2% drop in revenue from 2018 to 2020 (Cree’s fiscal year ends in June), which combined with an 8% rise in the outstanding share count, led to revenue-per-share dropping around 10% from $9.29 in 2018 to $8.37 in 2020.

Further, Cree’s P/S (price-to-sales) ratio dropped from 4.6x in 2018 to 4.4x in 2019, but has since jumped to 13.9x, riding the rally in technology stocks. Given that industrial demand is still not back up to pre-Covid levels, we believe there is a possible downside risk for the P/S multiple.

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So what’s the likely trigger and timing to this downside?

The global spread of Coronavirus has hampered demand for Cree’s Power and RF products from the industrial and automotive sectors, and demand has only just started rising to pre-Covid levels. Cree’s Q2 2021 results confirmed this, with revenue coming in only marginally higher at $127 million vs $120.7 million for the same period last year. A rise across all operating expense heads saw the net loss rise from $54 million to $83 million. This saw EPS drop to -$0.75 vs -$0.50 for the same period last year.

Going forward, we expect revenue growth to stay weak in the near to medium term, and if the company is not able to control expenses, we believe the stock will see its P/S multiple decline from the current level of almost 14x to around 11x, which combined with a reduction in revenues and margins could result in the stock price shrinking to as low as $90, a downside of over 20% from the current price near $116.

While Cree stock appears overvalued, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Intel vs Cisco.

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