The Fair Value Report

Cree, Inc.

This report is about Cree, Inc. and covers the company’s fiscal year ended June 30, 2021. Listed earnings and metrics utilizing earnings, are for that specific 12 month time period unless otherwise noted. Unaudited or reviewed financial information is not apart of, nor included in, this report.

My Disclaimer
I am a long-term, buy and hold investor, practicing a value investing philosophy. I am not a licensed or registered investment professional. I currently have NO investment position in the company mentioned in this report. Financial statement data was obtained from the company’s most recent Annual Report on Form 10-K.

Past and future gains contained herein are based on actual and anticipated earnings, actual and anticipated dividends, and actual and anticipated price appreciation. Valuations, while given as a specific amount, are always within a valuation range. Investors should be aware that any investment has the potential for loss, and past performance is no guarantee of future results.

What They Do
Cree, Inc. is an innovator of wide band gap semiconductors, focused on silicon carbide and gallium nitride (GaN) materials and devices for power and radio-frequency (RF) applications. The company’s silicon carbide and GaN materials and devices are targeted for applications such as transportation, power supplies, inverters and wireless systems.

During and prior to fiscal 2021, the company designed, manufactured and sold specialty lighting-class light emitting diode (LED) products targeted for use in indoor and outdoor lighting, electronic signs and signals and video displays. In March 2021, the company completed the sale of certain assets and subsidiaries comprising its former LED Products segment (the LED Business) to SMART Global Holdings, Inc. The company retained certain assets used in and pre-closing liabilities associated with the LED Products segment.

In addition, the company previously designed, manufactured and sold LED lighting fixtures and lamps for the commercial, industrial and consumer markets, referring to these product lines as the Lighting Products business unit. In May 2019, the Lighting Products business unit was sold to IDEAL Industries, Inc.

The company’s continuing operations consist of its Wolfspeed business, which includes silicon carbide and GaN materials, power devices and RF devices based on wide band gap semiconductor materials and silicon, used in power devices which are used in electric vehicles, motor drives, power supplies, solar and transportation applications, as well as in military communications, radar, satellite and telecommunication applications.

The majority of the company’s products are manufactured at its production facilities located in North Carolina, California and Arkansas. They also use contract manufacturers for certain products and aspects of product fabrication, assembly and packaging, and maintain captive lines at some of its contract manufacturers. The company is also in the process of building a silicon carbide device fabrication facility in New York, and continues to utilize its research and development facilities in North Carolina, California, Arkansas, Arizona and New York.

In January 2021, the company announced its plans to change its corporate name from Cree, Inc. to Wolfspeed, Inc. in the later part of fiscal 2022.

Order Backlog
The company’s backlog at the end of fiscal 2021 was approximately $763.9 million, compared with a backlog of approximately $602.7 million at the end of fiscal 2020. Management does not believe the company’s order backlog is necessarily indicative of actual net revenue for any future period, because of a number of factors, including manufacturing lead times and customer order patterns. Additionally, significant amounts of the company’s backlog relate to agreements that extend past one year.

The company manufactures silicon carbide substrates, silicon carbide MOSFETs, Schottky diodes and power modules as well as GaN on silicon carbide RF devices and LDMOS power transistors, utilizing manufacturing facilities located in the United States in combination with assembly and test subcontractors throughout Asia. Manufacturing assets are managed together through one centralized organization to ensure we leverage scale in asset utilization, purchasing volumes, and overhead costs across the business.

Silicon carbide substrate manufacturing occurs in the company’s materials factory and involves production of a bare wafer substrate with or without epitaxy. The front-end processes occur in manufacturing facilities called “wafer fabs”. These processes involve several hundred manufacturing steps required for imprinting silicon carbide wafers with the precise circuitry required for semiconductor devices to function. Back-end processes include the assembly, test and packaging of semiconductors to make them suitable for use and sale.

Yields in the manufacturing process can vary and are dependent upon multiple factors including product complexity and performance requirements as well as the maturity of the process. In order to maximize both yield and quality, the company maintains in-line process monitoring and testing with the company’s substrate and wafer fab manufacturing facilities certified to ISO 9001, IATF 16949 (automotive), and ISO 14001 (environmental). ISO 9001 is the international standard that specifies requirements for a quality management system and focuses on the ability to consistently provide products and services that meet customer requirements. IATF 16949 is the highest international quality standard for the automotive industry. ISO 14001 is an internationally agreed upon standard for an environmental management system.

Raw Materials
The company depends on a number of suppliers for certain raw materials, components and equipment used in manufacturing our products, including certain key materials and equipment used in critical stages of our manufacturing processes. In select cases, contracts have been purchased with suppliers in place to help insure supply. In other cases, items are purchased pursuant to discrete purchase orders.

The company’s suppliers are located around the world and can be subject to constraints beyond the company’s control, thus limiting supply. Management believes that its current supply of essential materials is sufficient to meet manufacturing needs. However, shortages have occurred from time to time and could occur again, espceially as related to the on-going COVID-19 pandemic. For raw materials used in semiconductor production, the global semiconductor shortage has put pressure on the ability to obtain some raw materials. Managment has focused on forecasting demand further out in time in order to secure raw materials that may have extended lead times.

The company also continues to experience impacts with logistics, including backed up ports and cargo shipment and airline shipment delays. The company has thus far been successful in managing through these issues and management believes operations are currently not materially impacted.

The company’s suppliers are located around the world and can be subject to constraints beyond the company’s control, thus limiting supply. Management believes that its current supply of essential materials is sufficient to meet manufacturing needs. However, shortages have occurred from time to time and could occur again, especially as related to the on-going COVID-19 pandemic. For raw materials used in semiconductor production, the global semiconductor shortage has put pressure on the ability to obtain some raw materials. Management has focused on forecasting demand further out in time in order to secure raw materials that may have extended lead times.

The company also continues to experience impacts with logistics, including backed up ports and cargo shipment and airline shipment delays. The company has thus far been successful in managing through these issues and management believes operations are currently not materially impacted.

Silicon Carbide and GaN Materials Competition
The company continues to maintain a well-established leadership position in the sale of silicon carbide wafer and silicon carbide and GaN epitaxy products. As market adoption of the technology grows with rapidly expanding power and RF device designs, the company has experienced increased competition from companies such as II-VI Advanced Materials, SiCrystal GmbH, IQE plc and Showa Denko K.K. Considering the current competitive increase for Silicon Carbide and GaN Materials, management believes its leading technology and leveraged production scale position the company to reliably supply production volumes to the device manufacturers in the market.

Power Devices Competition
The company’s silicon carbide based power devices compete with silicon carbide power semiconductor solutions offered by Infineon Technologies AG, Mitsubishi Electric Corporation (Mitsubishi), ON Semiconductor Corporation, Rohm Co. Ltd., and ST Microelectronics, and the company’s silicon carbide products also compete with silicon semiconductor devices offered by a variety of manufacturers. Power products compete in the power semiconductor market on the basis of performance, reliability and overall system price.

RF Device Competition
The company’s RF devices compete with Ampleon Netherlands B.V., M/A-COM Technology Solutions Inc., BOWEI Integrated Circuits Co., Ltd., Mitsubishi, NXP Semiconductor N.V., RFHIC, Qorvo, Inc. and Sumitomo, which all offer competing RF products and solutions. The company’s products also compete with a variety of companies offering silicon and GaAs-based products. Competition in the RF semiconductor market is based reliability, performance, design predictability and overall system price.

Patents and Other Intellectual Property Rights
Management believes it is important to protect the company’s investment in technology by obtaining and enforcing intellectual property rights, including rights under patent, trademark, trade secret and copyright laws. Accordingly the company seeks to protect its inventions by applying for patents in the United States and other countries when appropriate. In addition, the company has acquired, through license grants, purchases and assignments, rights to patents on inventions originally developed by others.

At the end of fiscal 2021, the company owned or were the exclusive licensee of 674 issued U.S. patents and approximately 1,425 foreign patents with various expiration dates extending up to 2045, with certain patents expiring in the near term. The company does not consider its business to be materially dependent upon any one patent, and believes business would not be materially adversely affected by the expiration of any one patent. For proprietary technology that is not patented, the company generally seeks to protect the technology and related know-how and information as trade secrets by keeping the information that management believes provides a competitive advantage, confidential.

Forward Outlook/Growth
Management believes that the company’s potential for growth depends on the significant adoption of the company’s products within the markets they serve. To be effective in continuing to grow and in managing that growth management has said that the company must maintain, expand, construct and purchase adequate manufacturing facilities and equipment, as well as secure sufficient third-party manufacturing resources, to meet customer demand, including specifically the expansion of its silicon carbide capacity with the construction of a state-of-the-art, automated 200mm capable silicon carbide device fabrication facility and an expansion of the company’s materials factory.

In addition, management believes the company must manage an increasingly complex supply chain that has the ability to supply an increasing number of raw materials, subsystems and finished products with the required specifications and quality, and deliver on time to the company’s manufacturing facilities, third-party manufacturing facilities, logistics operations, and customers. Further, the company must expand the capability of its information systems to support a more complex business, such as its current initiative to implement a new company-wide enterprise resource planning (ERP) system and be successful in securing design-ins across its end markets, including automotive applications.

Other forward growth items of note include the expansion of the company’s research and development, sales and marketing, technical support, distribution capabilities, manufacturing planning and administrative functions, the safeguarding of confidential information and protection of intellectual property, the management of organizational complexity and communication, the expansion of the current management team’s skills and capabilities, as well as the addition of experienced senior level managers and executives

Fiscal 2021 Finacial Statement Information
The information that follows is the result of calculations and metrics utilized in my worksheet and should be validated as part of the normal course of due diligence by any investor utilizing this report.

Short-Term Target
My current short-term target for the stock is $103 with an initial trailing stop set at $82. Based on a recent price of $82.76, upward price movement will find resistance at $88.21 and again at $93.74, with final resistance found at $98.35. Downward price movement will find support at $78.82 and again at $77.97, with final support found at $76.74.

One-Year Growth Price Target
My one year growth price target is actually a price target range, determined by adding year over year earning growth to the prior year annual dividend yield and dividing the result by the current annual price to earnings ratio.

For this stock, my current one year growth price target range is $98-$105.

Volatility Adjustment
There are different metrics available to help investors determine the volatility of a particular stock as compared to the volatility of the market as a whole. To me, the beta ratio is the metric that is the most representative of a stock’s volatility. A beta ratio of less than 1 means that the security’s price will be less volatile than the market, while a beta ratio greater than 1 indicates that the security’s price will be more volatile than the market.

Basis my current beta ratio for this stock of 1.48, my volatility adjustment to recent pricing is $27 per share, making my current volatility adjusted price $56.

Quality of Earnings
A company’s earnings can be impacted by a variety of sources unrelated to the company’s current day to day operations. Discontinued operations, tax refunds, depreciation, and impairment for example, may distort a company’s operating income and consequently its fair value. Investors should always explore the sources of a company’s operating income to better understand potential valuation impacts, both positive and negative.

Of the company’s $(2.94) per share in fiscal 2021 pre-tax income, $0 per share came from some combination of other sources, income taxes, interest, minority interests, or discontinued operations.

Key Performance Indicator Rating
I use key performance indicators (KPIs) as a barometer to measure the effectiveness of management. Several of the metrics that I use are the tangible asset ratio, return on invested capital, free cash flow growth, earnings growth, debt growth, the dividend payout ratio, and the cash conversion cycle. Admittedly, my use of these and other metrics as a way to determine the effectiveness of management is subjective. Based on a 0-105 scale, my KPI for this company is 55.

Shareholder Return
I calculate shareholder return by subtracting the stock price at the close of business on the last day of a company’s fiscal year, from the stock price at the start of business on the first day of the company’s fiscal year, plus any dividends paid during that period, and then dividing the result by the opening stock price on the first day of a company’s fiscal year.

For fiscal 2021, the company spent $0 per share buying back company stock, paid a common stock dividend of $0 per share, and had year-over-year annual price appreciation of $38.74, which created a shareholder return of 65%.

Over the prior five year period, the company spent an average of $0.51 per share buying back company stock, paid an average annual common stock dividend of $0 per share, and had average annual price appreciation of $6.63, which created an average shareholder return of 21%. The company has never paid a dividend.

Cost of Common Equity
The cost of common equity is the minimum annual rate of return an investor should expect to earn when investing in shares of a particular company. I calculate this by adding the thirty-year treasury yield to the beta ratio for the stock multiplied by my default equity risk premium.

My cost of common equity for this stock is 6.32%.

Weighted Average Cost of Capital
There is little in this world that does not come with some form of cost. Capital, which I define as cash used by a company for productive purposes and includes equity, debt, preferred stock, and dividends, is no exception. The weighted average cost of capital then, in simple terms, is the average cost the company pays for the necessary capital to operate its business and is proportionate to equity, debt, preferred stock, and dividends.

My weighted average cost of capital for this company is 3.39%.

The Year-Over-Year Numbers
There are many year-over-year numbers for investors to focus on. But to me, there are only a handful that have any significant meaning, and so those are the numbers that I highlight in this space. Please remember these are year-over-year numbers.

For fiscal 2021, revenue increased 12%, earnings increased 99%, free cash flow increased 91%, and debt increased 5%. Additionally, the company’s annual operating rate, which I calculate by adding operating expenses to the cost of goods sold and dividing the result by net sales, was 148.

Current Price Ratios
Investing requires effort. Value investing requires patience. Stock prices require consideration. As a way to screen a company to determine if it is worth my effort, patience and consideration, I use several price comparison ratios.

With a recent price of $82.76, the current Price to Earnings Ratio is (24), the Price to Book Ratio is 5, the Price to Tangible Book Value is 6, the Price to Debt Ratio is 11, and the Price to Free Cash Flow Ratio is (14). The company’s Return on Invested Capital is 19%, its Return on Assets is 12% and its Return on Equity is 19%.

Risk/Reward Ratio
I determine my risk reward ratio by subtracting my current terminate target from a recent price and then dividing that result by my initiate target less a price fluctuation variable of 20%. What I am looking for with this ratio is a value of 5 or greater. My risk/reward ratio for this stock is 24.

Prior Five Year Averages
My average valuation for the prior five year fiscal period was $(4). The stock price during that time period averaged $41, earnings averaged $(1.09) per share, and the average PE Ratio was (38).

Past and Future Estimated Values
Estimated values have nothing to do with fair value. Rather they are exactly as descibed, estimated, and as such are given to a wide variety of price fluctuations. It is important that investors realize that positions in a stock my be started, extended, or closed, anywhere within the estimated Five Year Value Range. Such additions or changes to positions will impact the average annual return.

For this stock, my Prior Five Year Estimated Value range was from $25 to $162, with an average of $79. The average year end price over that prior five year period of 2016 through 2020 was $56 and my estimated average annual return for that period was 8%. The actual shareholder return was 21%, an average annual return of 4.2%. My estimated Future Five Year Estimated Value range is $100 to $213, an averarge increase of 17% over the five year period, or an average annual return of 3.4%.

Fair Value Investing
It is important to remember that the current market price of an equity is the price negotiated between a willing buyer and a willing seller. This market price is not the fair value of the associated company, but the negotiated price of a single equity trade.

The basic investing tenet for a fair value investor remains price determines return. As such it is important to have some understanding of the value of the company as an on-going concern, and to develop a strategy that, with current value in mind, will allow investment in that company at some reasonable discount to current pricing. Accordingly, while earning are a major factor in determing the fair value of a stock, the single biggest influence on fair value comes from Free Cash Flow After Dividends, which for this company for fiscal 2021 was $(5.87).

Considering the company’s most recent earings and free cash flow after dividends, my most recent fair value estimate for the stock of this company as an on-going concern is $(46). This estimated fair value forms the basis for my target prices as shown on my worksheet.

Cree, Inc. (Nasdaq: CREE) – FYE 06/2021 – OVER VALUED – The stock is currently trading at levels above my most recent $(74) terminate target. Please See Linked PDF Worksheet.

Thanx for reading.

Revised on 08/22/2021