OmniVision Looks Fueled Up For Another Run

By Stephen D. Simpson, CFA | September 05, 2012 AAA

CMOS sensor company Omnivistion Technologies (Nasdaq:OVTI) has a crazy stock. Pull up a long-term chart, and you're basically looking at a map of the Tetons or some such. That chart also says a lot about the business. While Omnivision has long been at the edge of technology in the space, the company has been unable to establish a steady revenue and profit growth trajectory. While I don't expect that basic pattern of volatility to change much, investors may want to consider this stock for the potential sales and profit growth that could be reported with the next major Apple (Nasdaq:AAPL) phone launch.

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Mixed Numbers and Very Mixed Guidance
OmniVision posted some first quarter results and guidance that definitely require some explanations. Revenue fell almost 7% from last year, but rose 18% from the prior quarter and did OK relative to analyst expectations. OmniVision shipped 13% more sensors this quarter, with ASPs rising about 5%. Profitability continues to be very problematic. Gross margin fell more than three points sequentially (and more than 12 points from last year) to about 19% - a level that could be a record low for the company. Nevertheless, the company didn't really miss by much when it came to pro-forma per-share earnings, even though the company did post a GAAP operating loss.

Guidance was also very interesting. OmniVision management offered a huge upgrade in terms of revenue - offering a range of $355 million to $390 million versus a prior average guess of around $270 million. Unfortunately, profits are apparently not going to improve as notably, as management's EPS guidance range of 21 to 37 cents doesn't bracket the existing estimate of 33 cents especially favorably.

SEE: Can Earnings Guidance Accurately Predict The Future?

Build It ... and the Profits Will Come?
OmniVision is clearly suffering from a major inventory build ahead of new mobile product launches. The company's inventory level of over $400 million was also a record for the company, and the company has chosen to commit to additional capacity at Taiwan Semiconductor (NYSE:TSM). It seems clear to me why the company is doing this - it's expecting significant business tied to the new upcoming iPhone. Unfortunately, supplying Apple is a little like Fight Club - the first rule is that you cannot talk about it. Now I don't know whether the company won the much-valued back-facing high-resolution slot for the new phone (and there are ample rumors that it has not), but OmniVision's inventory build suggests that management expects a large amount of business.

While this inventory build hurts results today and does expose the company to some risk, I don't see the alternative. Production/quality issues in the past opened a door for rival CMOS sensor vendor Sony (NYSE:SNE) to gain share at Apple, and the company can't afford a repeat. Assuming that OmniVision can keep Apple happy (and that the next iPhone is a big success), the costs should work themselves out and OmniVision should report solid profits down the line.

SEE: Inventory Valuation For Investors: FIFO And LIFO

Is There A Stable Model?
If I have a big complaint with OmniVision, it's that the company's technological edge has never seemed to translate into consistent strong financial performance. Unfortunately, I'm not sure that is going to change much. Mobile phones look like it will always be a cyclical launch-driven business, and rival products from Sony, Sharp, Toshiba, and STMicroelectronics (NYSE:STM) mitigate the opportunity to win enough business to stabilize results across launch cycles. What's more, I'm just not sure there's enough high-value demand in markets like entertainment to really smooth out results.

Last and not least, I hope investors are not putting too much hope on ultrabooks. I know plenty of investors think these will be game-changers for Intel (Nasdaq:INTC) and Microsoft (Nasdaq:MSFT). What's more, there's a similar story between OmniVision and Atmel (Nasdaq:ATML) insofar as the hope that strong ultrabook design wins and consumer demand will help offset cyclicality and price erosion in cellphones. It's not so much that I think ultrabooks are going to fail, but rather I think it makes more sense to be cautious ahead of the launches.

SEE: The Ups And Downs Of Investing In Cyclical Stocks

The Bottom Line
Modeling out even five years of free cash flow for OmniVision seems like a Sisyphean task, let alone a full decade. Analysts rarely forecast the sort of volatility that companies like OmniVision actually often see, and even those who try usually get it wrong. Therefore, while I can produce scenarios that suggest the shares could be worth $30 or more even with an abnormally high discount rate, I have serious doubts that the company will actually report sustainable multi-year stretches of revenue and cash flow growth.

On the other hand, let's go back to the OmniVision chart. This stock soared when times were good, but now it looks like the stock may have bottomed from a technical perspective. What's more, the stock trades at an EV/revenue of less than 1.0, despite a credible scenario for near-term revenue acceleration. While the volatility of this stock definitely makes this a risky play, I think aggressive investors ought to be considering OmniVision as a potential winner for late 2012.

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

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