Seeking Alpha
Long only, contrarian, event-driven
Profile| Send Message|
( followers)  

Investors are struggling to find a way to play the growth in mobile smartphones and tablets. Shares in companies thought to be beneficiaries in its growth are falling. NVIDIA (NASDAQ:NVDA), whose Tegra sales must offset a drop in PCs, is down nearly 30% from its 52-week high. Delayed purchases in PCs, along with weak demand for ultrabooks, also hurt bell-weathers including Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC), and Dell (NASDAQ:DELL). One company offsetting weak sales from PC-customers is OmniVision (NASDAQ:OVTI). OmniVision is working past its operational challenges, and is becoming a better investing idea for investors who want exposure to the growth in the mobile market.

Challenges

For the last few quarters, OmniVision experienced weak profit margins, rising inventory and high costs. Since addressing costs, the company appears capable of improving its profit margins as the company ramps up unit sales.

Inventory rose steadily in the last four quarters:

1/31/2012

4/30/2012

7/31/2012

10/31/2012

247.27

291.34

403.2

398.69

(values in millions USD)

Data Source: Kapitall.com

Inventory levels are nearly triple the amount from fiscal 2009-2011. OmniVision is scaling its production size to accommodate for a larger market share, a big shift from its past business model. With a market capitalization of $800.51M, OmniVision is betting that it can sacrifice profits in the short-term to gain market share for the long-term.

Despite the challenges, there are three reasons to anticipate upside in shares of OmniVision Technology.

1) Market Growth

Between 2005 to 2011, the market for CMOS image sensors grew 44% compounded annually. In that time, OmniVision grew revenue by 49%. OmniVision's OmniBSI-2 sensor is also a leading product. Since 2010, growth in the tablet segment represented a 63% compounded annual growth rate for OmniVision. In the notebook market, sales softened, but the company earned design wins. This would enable stronger demand if ultrabook demand improves.

For simplicity, investors should assume that the PC/ultrabook segment will decline. The majority of growth will come from mobile device demand.

2) Rising Shipments

OmniVision shipped 50% more units than its previous quarter, shipping 249 million units during its second quarter. Its average selling price was almost unchanged, at $1.56 compared to $1.55 in the prior quarter.

The average selling price could improve as the product mix shifts. As smartphones and tablets demand higher resolutions, demand for 5- and 8-megapixel sensors could grow. A decline in 2 megapixel and 1.3 megapixel sensors could also be expected over the next few quarters.

3) Innovation

The mobile market is innovating quickly. OmniVision is ensuring that it can fulfill demand for improved products. In its last quarter, the company launched OV88358, an improvement over the OmniBSI+ and OmniBSI-2 pixel architecture. These sensors have a 20% improvement in low-light performance, according to the company.

Financial Analysis

During its last quarter, OmniVision reported a decline in gross margins, to 16.6%. This is down from 19.1% in the prior quarter. Rising shipments for the OmniBSI-2 sensor accounted for the decline in margins. A write-down in older products was $3.7 million (net): $2.8 million came from the sale of written down inventory, and $6.5 million in additional allowances for excess and obsolete inventories was made.

In addition:

· Accounts receivable rose 74.7% to $249.3 million.

· R&D rose 5.2% to $3.04 million during the quarter.

· OmniVision earned $0.19 per diluted share last quarter.

Risks:

Carrying high inventories is a risk, and write-downs could occur if demand drops. As smartphone demand continue to rise, and rapid innovation demands for better specifications, OmniVision is well-positioned to meet customer demand.

This permanent shift is critical for OmniVision's success. The company experienced a sharp decline for sensors in the notebook and webcam market. While it remains to be seen if dropping demand is permanent, investors should anticipate revenue from the mobile market to be a greater proportion of total sales.

Valuation and Conclusion

By raising its inventory to meet growing demand, OmniVision is increasing risks for its shareholders. Inventory turns were 3.2 times last quarter, but the company could improve its inventory turnover to 4 to 5 times over the long-term. The industry average is 4.7 times (trailing twelve months). Management expressed this target as being its goal. The company should be able to meet its own guidance of $390 million to $425 million in revenue, or $0.13 to $0.30 per diluted share.

OmniVision has a book value of $16.52 share, and is trading at 0.9x that value. If the company earns $1.09 per diluted share, investors are buying the company for a 14x forward-earnings multiple. By comparison, NVIDIA's forward P/E is 13x. Comparing OmniVision to other mobile device suppliers, Nuance Communications (NASDAQ:NUAN) trades with a forward P/E of 17, while Synaptics (NASDAQ:SYNA) trades at a forward P/E of 28. With OmniVision relying much less than others in the PC sector, OmniVision appears to offer better relative value.

Source: Avoid PC Suppliers, Consider OmniVision Instead