Remember me? I'm the guy who advocatedOmnivision Technology (NASDAQ:OVTI) back in June. It subsequently went south, declining 45% by mid-August. I didn't waver, telling readers to get greedy with Omnivision after its fiscal first-quarter earnings report. Now here I am again, seemingly beating a dead horse. But things are different this time. The market finally seems to be catching on, with a big jump in price following the company's second-quarter numbers release and new-product announcement.
At first glance the numbers for the quarter do not seem to warrant such optimism. Reported revenue of $84.4 million was a touch lighter than the consensus, and the forecast for both revenue and profit next quarter was in line with expectations. However, per-share profit of $0.28 came in higher than the analyst estimate of $0.24 per share. This is due to gross margins of 43.6% (excluding a one-time credit due to settlement of a dispute), which compares favorably to the previous quarter's result of 40.2%. The higher gross margins during a transitional quarter most likely mean the 1.3 megapixel products are doing well.
More importantly, Omnivision confirmed that the transition to its OmniPixel lineup is going smoothly. The company also announced that its 5.0 megapixel CameraChip for digital cameras will appear in products in the first quarter of calendar 2005. This is the key event investors have been awaiting.
Keeping an eye on the competition
Despite its drop in price this year, Omnivision is still the market leader in its niche (providing image chips for camera phones). While it is true that the company faces growing competition from Micron (NYSE:MU), Agilent (NYSE:A), and STMicroelectronics (NYSE:STM), Omnivision keeps upping the ante. The 1.3 megapixel camera phones have hit the mainstream, and Omnivision already has the next generation ready to go. Samples of the OV2630, a 2.0 megapixel chip, are shipping, Omnivision announced yesterday.
The company has consistently been first to production with next-generation chips -- that's one reason why four out of the five major cell phone manufacturers are customers. With camera phones selling the way they are, no handset maker wants to be caught lagging in a megapixel comparison. Omnivision's technological advantage gives it much leverage here.
Constantly launching new products to one-up the competition (and itself) is great, but for a company like Omnivision, which does this so rapidly (its time to market for new products is 100 days), inventory management will always be an issue. Flipping to the balance sheet, we can see that Omnivision navigated this transitional quarter well, paring down inventories by 36% in the past six months.
Looking for new markets
Sure, there are risks. A long-term concern for Omnivision would be competitors catching up once mainstream camera phones hit the 4-5 megapixel range. There may well be a limit to how much resolution users would like out of a camera phone, and once this threshold is crossed -- assuming competitors then catch up -- the company's pricing power will be hit, and margins will fall. This is a definite worry, with revenue from camera phones making up 70% of this quarter's revenue.
Omnivision is aware of this; hence the diversification into digital cameras. But it does not stop there: Omnivision is looking into other applications for its sensors, in the automobile, security, and medical sectors, for example. It has already achieved some success in entertainment applications, with the Omnivision-based Sony (NYSE:SNE) Eye Toy selling more than a million in Europe alone. It has the lead in the camera-phone market and it's flush with more than $200 million in cash. Omnivision has both the time and the money to explore and develop new markets for its image sensors.
Rearview mirror
Let's recap. We know that this quarter was a transitional one for Omnivision. Here's why the transition was a success:
1. Revenue and earnings targets were met.
2. Margins increased.
3. Key new products were introduced.
4. Previously announced products are ready for market soon.
5. Inventories were successfully reduced.
Omnivision may not have blown away estimates or provided extremely strong guidance, but what it has accomplished this quarter has laid the foundation for future success. The new products that have been introduced position the company nicely to benefit from the huge growth markets of camera phones and digital cameras.
A glimpse of the future
Omnivision is still a bargain now. While this quarter may mark a departure from the triple-digit, year-on-year revenue and earnings growth it has enjoyed for many consecutive quarters, the market has overcompensated. The company has a price-to-earnings growth (PEG) ratio well below 1, and its trailing and forward P/E ratios are both below 20. For a debt-free, profitable tech company, which just generated $34.5 million in cash from operations, Omnivision is seriously undervalued. Add the possibility of a short squeeze any time there's a catalyst for the stock (as of November 8, short interest was more than a third of the float), and there is room for more reward in Omnivision yet.
Having suggested exercising greed toward Omnivision in my thoughts on its previous quarter, I now recommend to longs the virtue of patience. This is by no means my "I told you so" piece -- it is too premature for that. With consumer goods featuring its new products due in the first quarter next year, Omnivision has yet to peak. Now that its much-doubted transition has taken place successfully, Omnivision is set to shine.
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Fool contributor Tim Goh does not own any stake in the companies mentioned. The Motley Fool has a disclosure policy.
