Offering earnings guidance above analyst expectations is obviously a bullish sign, as over time, earnings growth follows sales growth. And when a company predicts greater sales or profits, we expect its stock price to soon follow.
Digital imaging specialist OmniVision Technologies (NASDAQ: OVTI) recently said fiscal third quarter earnings were going to come in between $0.33 and $0.46 per share, a more promising outlook than the $0.34 per share Wall Street was anticipating. But because it's selling more of its new, more advanced technology than before, margins are slipping even as the overall profit picture improves.
Gross margin in the second quarter fell 650 basis points to 16.6%, reflecting the impact the higher cost of its latest generation image sensors. Its foundry partner Taiwan Semiconductor Manufacturing (TSM 0.83%) is passing along to OmniVision the costs of upgrading its equipment to produce wafers at higher cost.
In a year that's seen its share of ups and downs (and more downs than ups), even the more hopeful guidance couldn't stem the decline in the stock, which has fallen 14% since it provided what should be considered an improved outlook for the quarter ahead.
Now don't go blindly buying -- or selling -- on this somewhat more bullish sentiment because you still need to do some research. It looks like the situation is improving, because revenue was also projected to come in well ahead of forecasts, so use the announcement as a jumping off point for additional research.
Rotten to the core?
One concern, obviously, is whether Apple (AAPL +0.11%) has taken as large a bite out of the smartphone market as it can. Analysts at two investment houses have suggested orders for the iPhone 5 are falling below estimates and are in fact being cut, so they've reduced their numbers to reflect their channel checks. If that is truly the case, then suppliers like OmniVision and Cirrus Logic (CRUS +0.05%), which relies upon Apple for more than half its revenue, will eventually feel the pinch.
But if the full extent of the analysis is read, it might not be as bad for OmniVision as it might be for some other suppliers like TriQuint Semiconductor (TQNT +0.00%) and Skyworks Solutions (SWKS +3.70%). That's because the analysts also noted that it's not just about the iPhone, but also the iPad and how the newest iteration of the tablet, the iPad Mini, is cannibalizing sales of the larger version. Yet whichever version sells, OmniVision's image sensors are included (TriQuint and Skyworks chips didn't make it into the tablets).
A group buy
Wall Street was unimpressed with the results of Apple's entrance into China, but even the gloomy pros acknowledge its deal with China Mobile (CHL +0.00%) has the potential to expand sales dramatically, beginning with the December quarter. Yet they might end up being surprised at Apple's strength when the numbers actually come in, as TechCrunch reports it has used more third-party resellers to avoid the same mad rush and chaos that marked the release of the iPhone 4S. With China Unicom (CHU +0.00%) and China Telecom (CHA +0.00%) reporting strong sales, the picture may be much better than what the investment houses are giving it credit for.
The ramp-up in Apple's products boosted OmniVision's prospects earlier this year and management admitted it was going to run into margin pressure, so it shouldn't have been a surprise. Despite analysts' contention to the contrary, management remains bullish about demand and they believe next quarter will be just as strong as the second. Because the second and third quarters are historically its best, investors shouldn't be worried to see business flag in the fourth.
At less than eight times earnings estimates, OmniVision is comparably priced to other Apple suppliers like Cirrus and TriQuint, but its positioning within the tablet ecosystem may give it an advantage some others may not have. I think Wall Street's outlook on the China syndrome may be skewed and I believe they'll say they're surprised at its strength when the numbers finally come in. The weakness OmniVision (and some other suppliers) exhibit as a result of the current outlook may indicate this is a buying opportunity after all.
