Stay Away From This Apple Inc Supplier Going Into Earnings

Judgment day is coming for OmniVision Technologies (NASDAQ: OVTI  ) . After stoking investors' enthusiasm with a terrific third-quarter earnings report and an upbeat outlook, OmniVision will need to prove that its performance wasn't just another flash in the pan when it reports its fourth-quarter on May 29. Known for supplying image sensors to Apple (NASDAQ: AAPL  ) , OmniVision has struggled due to competition from Sony (NYSE: SNE  ) , and it is not growing at the fast-paced rate it was last year.

However, one positive report from OmniVision has sent the stock soaring in 2014, up about 13%. And when the company releases its fourth-quarter report, investors can be assured that it will at least meet estimates considering the outlook that it had issued last time. But then, a closer look at OmniVision will reveal deeper problems.

Don't be too optimistic
The company's revenue is expected to drop 13.5% year over year, and the bottom line is expected to shrink to $0.26 per share from $0.31 per share last year. OmniVision's valuation is not great either. In fact, its forward earnings multiple of 14.5 is more than the trailing multiple of 12, indicating a slowdown.

As such, OmniVision will need to issue a pretty strong outlook once again to prove that it is firmly on the comeback trail, and is capable of justifying the 20% five-year annual growth rate that analysts expect. However, it is difficult to count on OmniVision. The company has disappointed investors on many occasions in the last couple of years and it is difficult to predict how its outlook might look like. At best, it is a moving target that goes from the left to the right at the drop of a hat.

Will Apple be a savior?
Investors shouldn't be betting that OmniVision's Apple supplier status puts it in a prime position to benefit from the revolutionary iPhones that Cupertino releases every year. OmniVision had supplied sensors for the iPhone 5s, but its business at Apple has been under threat from Sony. The Japanese conglomerate shares the image sensor spot in the iPhones with OmniVision, but it has been gradually gaining more share.

Moreover, given Sony's size and manufacturing infrastructure, it can easily control costs and offer more efficient products to Apple at a lower price. Image sensors are commodities, and so, companies with greater economies of scale are at an advantage. OmniVision is a sixteenth of Sony in terms of market cap, so it is evident which is the bigger player over here.

However, since Apple is expected to produce a remarkable 80 million iPhones this year, OmniVision might enjoy some tailwinds as production ramps up. Coupled with the China Mobile deal and the expected launch of bigger iPhones, Apple might need to produce more devices, and hence depend on more than one supplier in order to avoid supply chain issues. This is where OmniVision might benefit if it manages to land the design win once again this time.

Focusing on China
For OmniVision, the bulk of growth might come from the Chinese market, or more specifically, low-cost smartphones. The company has been launching chips aimed at this market, such as the OV5670 PureCel image sensor. This chip is capable of capturing full resolution 5-megapixel images at 30 frames per second and consumes 35% less power than OmniVision's previous generation sensor. This looks like a smart move, as the Chinese smartphone market is expected to grow in leaps and bounds going forward.

The roll out of LTE in China is expected to be a big driver for smartphone sales. According to IHS, shipments of LTE smartphones are expected to hit 72.4 million units this year, up nearly 1,500% from only 4.6 million last year. By 2017, this number is expected to grow to almost 300 million units.

So, this is one area where OmniVision can see growth as it doesn't have an able competitor in the 5 megapixel and 8 megapixel budget category yet, according to Oppenheimer. But, investors should keep in mind that image sensor chips are a commodity, and the emergence of a low-cost competitor could hurt OmniVision's prospects.

The bottom line
OmniVision is carrying good momentum into its fourth-quarter report, but it is foolish (with a small "f") to be sure that the company will sustain it. The company has burned investors quite a few times in the past, and until and unless it brings about consistency in its performance, it isn't a buy.

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