For OmniVision, Weird Is Just Its Version Of Normal

By Stephen D. Simpson, CFA | November 29, 2012 AAA

It seems like nothing is ever normal with CMOS image sensor company, OmniVision Technologies (Nasdaq:OVTI). Accept that and it can be an intriguingly volatile trading opportunity. While the stock has often been batted around on rumors, worries and hopes tied to adoption from key customers like Apple (Nasdaq:AAPL), now margins have become another big variable. Consequently, while very strong revenue guidance for the next quarter really jumps, so to does the possibility of ongoing margin pressure. Not surprisingly, that continues to make this a very difficult company to model and a difficult stock to recommend or own.

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Plenty to Chew on in Fiscal Q2
OmniVision quarters are rarely boring and this was no exception. Revenue rose 79% from last year, as shipments soared 62% from last year and 50% from the prior quarter. While shipments of sensors with two megapixels or more rose just 26% from the first quarter, shipments of 1.3 megapixel sensors soared 132%. ASPs were basically steady on a sequential basis, while the company saw mobile applications (phones and tablets) jump to 59% of the business (from 48% in the fiscal first quarter).

While the revenue number was good news, the margin information was not nearly as positive. OmniVision set a record low for gross margin in the fiscal first quarter, only to beat that record as gross margin fell another 2.5 points. This margin pressure is coming from the transition to more advanced products, and a majority of BSI-2 costs were recognized this quarter. Operating income fell about 30% from last year, but the company did at least reverse the prior quarter's operating loss.

Guidance Has Good News ... and Bad News
Very few chip stocks have gotten through this reporting cycle without revising down their next quarter's guidance, with many companies trimming revenue by a mid-to-high single-digit percentage relative to prior Street estimates.

Not OmniVision, though. No, OmniVision boosted revenue guidance to between $390 million and $425 million - the midpoint being about 11% above the prior average estimate of $366 million. Normally you might think that would mean that OmniVision is doing well, relative to competitors like Sony (NYSE:SNE) or Toshiba (OTC:TOSYY), but there's a substantial "but" here. That "but" is that the gross margins are going to continue to be weak; while the midpoint of management's EPS guidance range of 33 cents to 46 cents was almost 13% higher than the prior average estimate, there's a possibility there on the low end that EPS will actually be lower than previously expected, despite the much higher revenue.

Inventories, Customers and Competitors
Some of OmniVision's EPS risk is likely tied to moving more of that considerable inventory (nearly $400 million against $390 million in revenue), as well as working with Taiwan Semiconductor (NYSE:TSM) to fine-tune its orders and drive down the cost on the new BSI-2 sensors, which are supposedly ramping well with customers.

Speaking of customers, the mix could also be a threat to margins. OmniVision bulls had to be disappointed that the company did not beat out Sony for the back-facing camera slot on the latest Apple iPhone, and this quarter saw a big increase in demand for sensors for devices for the Asian (presumably Chinese) market. While it's not like OmniVision's high-end products are a margin bonanza right now, average selling price (ASPs) and profits for supplying into the Chinese market aren't usually all that strong - at least not in comparison to North American smartphones.

On the competition side, it sounds like the BSI-2 is ramping up now, and that should be a good thing for OmniVision. But then there's the risk that Sony, Toshiba and/or Samsung are going to ramp up their efforts as well.

The Bottom Line
OmniVision looks pretty cheap on metrics like price/book and EV/sales, but growth investors seldom pay much attention to those numbers when picking tech stocks - particularly when the numbers are low.

Unfortunately, EV/EBTIDA and free cash flow analysis are scarcely more helpful now. OmniVision's EV/EBITDA ratio is elevated due to its margin issues, but assuming that margins get better is essentially a bullish call, anyway. Likewise, it's not hard to construct a cash flow model that points to real value in these shares, but investors have to be very careful not to confuse precision with accuracy; when it comes to predicting OmniVision's cash flow in five years, it is very hard to feel confident. Consequently, while I'd say I'm bullishly inclined toward these shares, the intrinsic weirdness is just more hassle than I need in my investing life.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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