Up More Than 2x Since March, Cree Stock Headed Back Down?

After a 108% rise since its low in March, at the current price of around $60 per share we believe Cree stock (NASDAQ: CREE) has reached its near term potential. The stock has crossed the level it was at before the drop in March, but in reality, demand and revenues will likely be affected this year. Cree stock has already rallied from $29 to $60 off the recent bottom compared to the S&P which moved 53%.

Further, Cree stock is up about 42% from levels seen at the end of 2018, over 1.5 years ago. This rise came despite a 2% decrease in Cree’s revenue from 2018 to 2020 (Cree’s fiscal year ends in June), which combined with a 5% increase in the outstanding share count, led to a 7% drop in revenue per share.

Further, its P/S multiple saw a decrease from 4.6x in 2018 to 4.3x in 2019, but has risen rapidly to around 7x, as the company is expected to benefit from the global launch of 5G. However, we believe the stock is unlikely to see significant upside after the recent rally, owing to the potential weakness from a recession driven by the Covid outbreak. Our interactive dashboard What Factors Drove 42% Change in Cree Stock between 2018 and now? has the underlying numbers.

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

The global spread of Coronavirus has meant there is much lower demand for electric vehicles and the global launch of 5G has also been pushed back. The effect of this on Cree’s business is evident from their FY 2020 earnings, where revenue came in at $904 million, down from $1.08 billion in 2019. Further, an increase in R&D and SG&A expenses, saw net loss more than triple from $58 million in 2019 to $191 million in 2020. We expect this trend to continue in 1H 2021, with an expected Y-o-Y drop in Q1 and Q2 2021, as 5G technology has still not been rolled out globally, and demand for LED products has not risen back to pre-Covid levels.

Regardless, if there isn’t clear evidence of containment of the virus anytime soon, we believe the stock will see its P/S decline from the current level of 7x to around 6x, which combined with a slight reduction in revenues and margins could result in the stock price shrinking to around $50.

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