Why You Shouldn’t Buy OmniVision’s Outlook

Chipmaker OmniVision Technologies (NASDAQ: OVTI  ) soared more than 10% after reporting outstanding third-quarter results and a sunny outlook. Investors would certainly be surprised by the guidance that OmniVision issued for the current quarter, especially after the series of cloudy forecasts that the company provided in the past few quarters. While headlines were positive for this Apple (NASDAQ: AAPL  ) supplier, this is not a stock for the faint-hearted.

The tag line of The Motley Fool's 10% Promise Series article on OmniVision says, "Is OmniVision's jump meaningful? Or just another movement?" For those who have been following the stock over the past two-and-a-half years, this might be just another movement. OmniVision has given investors a roller-coaster ride that would probably put the Millennium Force to shame, and it won't be surprising if another descent is in the cards. Let's see why.

Great, but not so great
The Street heartily applauded OmniVision's scaled-down performance. The company's revenue dropped 17% year-over-year to $352 million, blowing past the analyst estimate of $326 million. However, the estimate was lowered from the original $402 million after OmniVision issued a weak outlook in the preceding quarter.  

Also, financial media seems to be quite impressed by the fact that OmniVision reported earnings of $0.69 per share, almost double the $0.35 consensus. But, this contained a one-time gain of $0.28 per share due to OmniVision's investment in a Chinese company that went public. So, effectively, OmniVision earned $0.41 per share, which was behind the original expectation of $0.43 per share. 

But, who cares about past performance when the outlook ends up being outstanding. OmniVision is looking at revenue of $275 million-$305 million in the current quarter and earnings of $0.19-$0.35 per share, both well ahead of estimates. However, it is difficult to count upon OmniVision to sustain such an outlook in the future, as the company has failed to deliver on a number of occasions in the past.

Looking beyond the outlook
OmniVision management expects its new pixel technology to take it to the Promised Land. Its flagship 8-megapixel and 13-megapixel PureCel sensors are being adopted by key customers, and the company is ramping up production. OmniVision has landed design wins for its PureCel sensors at important Asian manufacturers based in China and Taiwan, the hot bed of smartphone growth these days.

Although the Chinese smartphone market shrunk in the previous quarter, the roll out of TD-LTE in the region can breathe life into the market. Hence, OmniVision could gain from this high-volume market. In addition, OmniVision should be praised for the fact that it has explored other areas to grow its business, even when its Apple account was declining.

OmniVision started losing business to Sony (NYSE: SNE  ) for camera sensors used in iPhones in 2011. Even though OmniVision supplied some sensors for the iPhone 5s, Sony has hogged all the limelight with the superior image quality delivered by its sensors.

However, OmniVision could gain some business as a result of Apple's foray into China, where the tech giant is expected to sell between 20 million-30 million units this year. Moreover, the introduction of large-screen devices by Apple could turn out to be another catalyst for iPhone and iPad sales in the future, bringing additional revenue for OmniVision.

But, Sony is a key player in the image sensor market, and its expertise in image sensors could hurt OmniVision further. Sony is also moving into wearable devices and gesture recognition, areas that OmniVision also expects to tap.  So, Sony's expertise and size of operations could enable it to capture the image sensor market in a faster, more efficient way than OmniVision.

Scale is important in the business of making chips, due to its commoditized nature. OmniVision is already seeing the effects of this commoditization -- the average selling price of its sensors fell to $1.64 per unit from $1.67, quarter-over-quarter, because of price declines across product lines in all markets.

Final words
While OmniVision's management might remain upbeat about the company's prospects in automotive, entertainment, and mobile, it is not the only player in this arena. Bigger corporations like Sony and Samsung enjoy greater economies of scale due to their size, so counting on OmniVision to deliver after just one great outlook is not a good idea.

The company might look cheap with a trailing P/E of just 10.9, but a higher forward P/E of 12.3 indicates that earnings growth might not be impressive going forward. Also, given OmniVision's inconsistent performances in the past, the robust outlook for the current quarter might turn out to be a one-time event.

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