OmniVision Technologies – The Beat(ing) Goes On

I've followed OmniVision Technologies (Nasdaq:OVTI) for quite a while now, but I've never owned the shares. In a nutshell, OmniVision seems to fit into that "it's more trouble than it's worth" category of stocks where severe operational volatility (that I don't believe the company really can or could do much to control) leads to big swings in the price. That may be fine for investors/traders who like active names that produce multiple trading opportunities for buy/sell moves within a year, but it is much less attractive to those of us who pursue an investment path of "enlightened torpor".

With that, OmniVision's fiscal first quarter (and guidance for the second quarter) was really just more of what I've learned to expect from this company. While I do believe OmniVision has good technology and a solid market position relative to the likes of Sony (NYSE:SNE) and Samsung, it's just such a difficult market to prosper in, particularly with the turbulence in the handset market right now.

Fiscal Q1 Comes In Light
Although it's hard to say that weakness in CMOS sensor demand tied to weaker handset shipments is a surprise, the fact remains that OmniVision came in a little light with first quarter results.

Revenue rose 45% this quarter (and 11% sequentially), coming in just above the midpoint of management's guidance for the quarter, but a just a touch shy of Wall Street's figure. Unit shipments were up 25% from last year (and up 11% sequentially), but ASPs were flat after five straight quarters of improvements. OmniVision's percentage of revenue from mobile devices didn't change much, but it was weaker than expected for this quarter. Also, it's worth noting that the company saw a smaller percentage of shipments in the 2 megapixel and above range (47% versus 50%).

Due at least in part to mix, OmniVision disappointed on margins. Gross margin dropped almost two points from last year and ticked down slightly on a sequential basis. Although operating income was up sharply from last year and up strongly on a sequential basis, it looks OmniVision missed on margins by about half a point.

Demand And Competition Still Loom Large
OmniVision wouldn't be the only handset-sensitive company to see an impact from slowing sales of high-end phones – it has appeared as a meaningful concern for others like Broadcom (Nasdaq:BRCM), Qualcomm (Nasdaq:QCOM), Atmel (Nasdaq:ATML), and Avago (Nasdaq:AVGO). As has been the case with others in the handset chip space, OmniVision is not only facing the prospect of slower sales of high-end phones (which typically include more advanced and lucrative components), but increasing competition from lower-cost suppliers in the low- and mid-range handset markets.

That leaves OmniVision in a tough position – Sony can pressure the company on the high end (and has done so at clients like Apple (Nasdaq:AAPL), while a variety of Asian suppliers are driving prices much lower for components going into lower-priced phones where "good enough is good enough" is more the order of the day.

To that end, management's guidance reflects a lot of those uncertainties. Although OmniVision's revenue guidance range for the next quarter did include the prior Street average, the new midpoint is about 4% below the Street. Likewise, while the wide EPS range includes the prior average estimate, the midpoint is about 10% lower than where the Street was looking.

The Bottom Line
There is certainly a chance that high-end handset demand could recover, but I think investors need to brace themselves for at least the possibility that that market is close to saturation. Likewise, while it is possible that ultrabook demand will eventually materialize and boost the potential addressable market for OmniVision (and Atmel in touch), I'm not sure I'd bet on that … and certainly not in the next couple of quarters.

I hate to say that valuation doesn't matter with OmniVision shares, but the reality is that this stock is wildly sensitive to quarter-to-quarter results and guidance, as the discounted fair value can swing wildly with just a few small adjustments to long-term revenue growth or margin assumptions. With all of that uncertainty, I'm not interested in these shares at this price, but those with more of an inclination towards trading should probably have this stock on their watchlist as it does tend to produce some pretty wide swings.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.