OmniVision plays in Growth Markets but is it a Value Trap?

omnivision logoOmniVision Technologies (NYSE: OVTI) has one of the cheapest valuations based on forward P/E among semi-conductor stocks.  Its end market outlooks are promising, with growth from mobile and other new markets expected to drive future sales.  That said, management recently issued an outlook that disappointed the Street, making the stock look like it could be a value trap.

However, growth in the Asian market and revenue acceleration from other areas paired with a moderate margin recovery could drive the shares higher over the NTM.   The biggest challenge is expanding margins in an environment where the ASPs just declined.

 

OVTI Produces Cameras for Phones and Other Technology

OmniVision Technologies designs, develops and markets semiconductor image-sensor devices around the world.  Its products serve the mobile phone, notebook and webcam, digital still, security and surveillance, entertainment, automobile and medical markets. In the July quarter, mobile phones, notebooks, entertainment and emerging areas (different from emerging markets like China) were 63%, 7%, 22% and 8% of sales, respectively.

OmniVision is the leading seller of CMOS image solutions and has the broadest portfolio of CMOS products.  It sells CameraChip image sensors that are single-chip solutions which integrate various functions of a processed image or video stream that is used in consumer and commercial mass-market devices.  OmniVision’s CameraCube imaging are image sensors with integrated wafer-level optics.  In addition to the image sensors, it also supplies companion chips used to connect the sensors and provides the software drivers for Linus, Apple OSX, and Microsoft Windows as well as mobile operating systems.  The company sells its products both directly to OEMs and through value added resellers as well as some their party distributors.  Competitors include

OmniVision had a record year in 2012, with 855 million units shipped and sales of $1.4 billion.  It also held market share of 30% in CMOS cameras.   The company expects its end markets will grow to 4.5 billion units in 2017, up from 2.5 billion in 2012.  Smart phones will act as the most significant driver of growth here, in particular growth in China and the developing world.  Tablets, security, wearable (such as watches and glasses) and automotive are the other high growth markets.

Omnivision Products

The mobile handset business is the most significant portion of sales with over $800 million in FY13 revenues.  It sells to all the major mobile OS systems, Google’s (NYSE: GOOG) Android, Apple’s (NASDAQ: AAPL) iOS, and Windows Mobile.  Along these lines, Apple’s results help offset pricing competition with the China market in the recent quarter. The geographic mix is if sakes is balanced and leveraged to the more rapid growth expected from Asia.  Management expects the Indian market will emerge as a larger opportunity, this could create upside to the market over the long-term.  Market growth and new product adoption is due to increasing demand for higher quality cameras on the back and now also on the front of phones.  The addition to cameras on the front of most phones led to a significant jump in demand in recent years.

The tablet market represents $300 million in FY13 revenue and the company has a 67% share worldwide.  OmniVision ships 8-megapixel, 5-megapixel, HD and VGA.  It continues to launch new products with higher resolutions and higher performance to participate in consumers demand for higher end products.  The PC business measured $100 million in FY13 despite challenges in the market.  In CY12 the company held a 51% market share in PC based offerings and shipped to the top eight PC OEMs globally.

 

Growth from New and Emerging Markets

Emerging markets generate a third of sales and will drive much of the future growth.  Its core markets in mobile continue to grow with consumers in emerging markets also demanding higher resolution camera.  This can increase the price point and possibly margins at OmniVision.  Management reports that front cameras are increasingly HD or full HD and notebooks, gaming and smart TVs are also experience resolution upgrades.

Management sees additional opportunities in the security, auto and other applications over the medium term.  For example, CCTV accounted for 92% of the security market in 2012, but forecasts from TSR expect IP will take an additional 11% share giving CCTV 81% of the market in 2016.  OmniVision participates in the IP portion of the market.

Auto is another growth area with manufacturers adding rear, front, side, grill and even interior cameras to future plans.  The cameras have a range of functional possibilities from rearward vision and blind spot detection to night vision and video conferencing.  OmniVision believes HDR will also increase its share here since it improves the performance of sensors, increasing driver safety.

Wearables are the next tier for the company in consumer technology.  That includes watches, eyewear and fitness products with uses for sensing, photography, gaming and video conferencing.  The actual size of this market is harder to define as it will be driven by consumer adoption of these currently cutting edge devices.  An acceleration in adoption would likely represent upside to current forecasts earnings.

 

Conclusion, Cheap Stock – Margins are the Key

OmniVision has $4.00 per share in cash and trades at 9.1x consensus FY14 EPS of $1.72 and 10.4x FY15 EPS of $1.50.  Comparable semis trade at around 14x FY14 earnings.

OmniVision faces some challenges in the near-term with increased competition in China that recently resulted in lower ASPs and pressuring margins.  However, its strong market share and attractive valuation make it look like a solid value play among the semis.   Also, margins did improve modesty in the most recent quarter, a positive sign.  For investors looking for value stocks in an increasingly expensive market, OmniVision is worth investigating further.  Potential investors should dive into margins and the pressure the company is getting in the Chinese market from SNY and HIMX.  These are key to understanding the earnings prospects and if it’s a buy or a sell.

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