This Apple Derivative Play Just Became a Bargain
Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
OmniVision Technologies (NASDAQ: OVTI) won’t just stop giving investors a heart attack. After a topsy-turvy ride last year, when OmniVision had to bear with Sony’s encroachment on its prized Apple (NASDAQ: AAPL) iPhone image sensor spot, the stock was having a better time in 2012. But OmniVision’s fourth quarter earnings report has thrown it off gear again.
Into the gory details
Everything was fine with OmniVision’s quarter as far as its top line was concerned. The company posted revenue of $218.5 million in the quarter, way ahead of the $205 million analysts were expecting and also ahead of its own forecast. However, it did miss on the bottom line, earning 20 cents a share as against the 22 expected by the Street. You might say; that’s not so bad mate. But the real problem came with OmniVision’s earnings forecast for the current quarter.
The company is expecting to make between 16 to 27 cents in the ongoing quarter, failing to touch the mark of the 28 cents analysts have modeled. The result, OmniVision plunged a massive 17% after its results. However, the company still expects to beat the Street’s top line expectations next quarter, as its revenue forecast of $235 million to $255 million is again miles ahead of the $219.2 million guesstimate.
An upbeat revenue forecast suggests that all’s fine as far as demand for its products is concerned. However, it’s the margins which have now begun playing spoilsport. OmniVision’s gross margin in the quarter contracted as if it was under the grip of a Boa Constrictor, dropping to 22% from 31% last year.
The suffocation of the gross margin arose out of two factors. Firstly, OmniVision’s top line dropped 15% from the year-ago period as the company sold inventory which it had written down previously. Again, the company created an additional provision for surplus and out of date inventories. These factors had a negative impact of almost $5 million on OmniVision’s margins. This trend has been continuing for the past two quarters and is expected to be seen in the current one as well.
OmniVision’s gross margin is under pressure due to increased shipments of its low margin BSI-2 sensor. The company is still ramping up the production of this device, as such, it seems as if hasn’t reached the optimum cost level for generating its ideal margin levels. Management believes that its margins woes would probably be limited to at least this quarter.
But problems won’t stay for long
However, I have enough reasons to believe that OmniVision is capable of fixing its margins, along with making investors richer as the year moves on. Hence, in my opinion, the massive drop in OmniVision’s price has opened up a huge opportunity for investors to cash in on the next iPhone.
As far as the margins are concerned, the problem of older inventories is something which is not there to stay forever. Also, word on the Street tells us that OmniVision is all set to feature in Apple’s next iPhone in a big way. OmniVision’s average selling price of a sensor gained momentum with the recently launched iPad, rising more than twice. And if the next version of the iPhone breaks all precedents in terms of units sold, OmniVision’s margins would certainly improve. Moreover, as the company keeps ramping up its new products, it would move down on the cost curve.
Opening up other Apple plays
In addition, it seems OmniVision’s negativity has also affected Apple’s other component suppliers. Both Skyworks Solutions (NASDAQ: SWKS) and Cirrus Logic (NASDAQ: CRUS) fell 6% and almost 10% respectively after OmniVision released its results. Now, Cirrus and Skyworks are both tried and tested Apple derivative plays. Both these companies expect great things towards the end of the year, an indication that they are ready to make hay while the iPhones fly off the shelves. Another thing common among the two is that they expect the current quarter to be somewhat muted as Apple empties its iPhone 4S inventories.
Bracing for the next iPhone
While going through the conference call, I tried to find a similar trend with OmniVision as with the other two suppliers. Management says that inventory levels have risen as its customers are buying more of its BSI-2 sensors. OmniVision had a different ramp-up schedule for this chip, but had to accelerate its production to meet demand, thereby stocking up on the old chips which have pressured margins. The company has made significant progress on selling its older inventories, a point that might stem from the fact that even Apple is doing the same with the iPhone 4S.
Also, management expects the inventory to return to normal levels by the end of the third quarter of this fiscal year. This is again an indication that OmniVision would ship out its older units by then and also see enough sales of the new sensors, probably driven to a large extent by the iPhone 5 (or whatever name Cupertino gives it).
The way I see it, OmniVision’s drop has opened up an opportunity to get into it. It has also opened up other lucrative Apple plays such as Skyworks and Cirrus as mentioned earlier. OmniVision won’t be hurt by depressed margins for long but it will probably do better as far as my analysis tells me. A 17% drop in price is certainly a bargain, especially considering what the future might bring along, and investors should definitely take note of it.
TechJunk13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Cirrus Logic. Motley Fool newsletter services recommend Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.