OmniVision Technologies, Incorporated (OVTI)

OVTI is the world’s leader in integrated complimentary metal oxide semiconductor (CMOS) image sensors. Their products are used mainly in digital cameras, cell phone cameras, security cameras, and video game consoles. Other uses include PC video cameras, personal digital assistants (PDAs), automobile sensors, video phones, medical instruments, bar code readers, and biometrics.

We find OmniVision Technology’s stock to be favourably valued in light of an analysis of the company's financial state, and the likelihood that they will find their products enviably positioned during the next 2-3 years.

The stock trades at 56.31 times trailing twelve months (ttm) earnings; while this is a significant premium to most stocks, it is not trading at a multiple much higher than most other semiconductor stocks (the industry average (ttm) P/E ratio is 56.12).

The stock trades with a P/EG ratio far below competitors, at 1.03 versus 2.01. This is a basic but significant sign that the company is undervalued.

The forward P/E ratio is 30.1 using consensus estimates. The forward P/EG ratio is 1.003. These ratios are slightly positive.

The company carries no debt, and has ample cash for moderate expansion and for operations. It is hence unlikely that a secondary offering will soon be issued.

OmniVision Technologies has grown earnings and revenues at a pace that far outstrips most other semiconductor firms; most recent quarter (mrq) revenues came in at 68.5 million, 215% above the same quarter of the prior year, and 455% above the equivalent 2002 revenues. Earnings show a similar picture, with second-quarter results this year, last year, and the year before being 0.39, 0.12, and -0.17, respectively.

It seems fair to expect that Omnivision will continue to outperform the industry as a growth company, since they operate in a newer, more rapidly growing, and less commoditized market than most other semiconductor companies.

The growth of demand for camera phones may begin to slow when most cell phones have been replaced. However, with expectations for this beginning at between 500,000,000 and 1,000,000,000 units, there is still certainly room to grow from the approximately 60,000,000 units today.

Demand for still digital cameras is expected to grow at a more modest rate. Although a considerable fraction of consumers are likely to adopt new digital cameras in the next several years, prices have already dropped to levels where a new accelerating growth trend is unlikely. However, new cameras and replacement cameras are more likely to contain OmniVision semiconductors in the future; CMOS image sensors have several attractive features that make them appealing for integration into new products, including lower power consumption, smaller size, and lower production costs.

Video game consoles have become increasingly interactive, and are now beyond the control pad. Games are now played over the Internet, and consoles are able to translate body motions into game input (with the help of OmniVision’s sensors). It is expected that this trend will continue. As a result, there may be considerable growth for OmniVision’s products in this sector. However, while sales may increase significantly within the sector, it is unlikely to make up a very large percentage of OmniVision’s total revenues.

Four sectors that OmniVision is currently exploring remain within the stage of initial adoption, and have the potential to become large markets. These are: Biometrics, video phones, automobile sensors, and PDAs.

Biometric devices companies have performed very well on public markets since 9/11, as major companies and government agencies have looked into uses of biometric devices for security. Scanners, such as those that OmniVision produces, are one strong possibility.

Video phones have yet to become widely adopted, and are likely to experience strong growth just as the camera phones market wanes. Should OmniVision manage to grasp significant market share, this sector could fuel strong earnings growth.

Automobile sensors are one of the latest safety innovations being incorporated into new designs. Major car manufacturers have adopted this technology, and begun marketing campaigns based on the product.

PDAs have recently been adopting camera capabilities. For example, the new Zire 71 has a built in digital camera. While this sector is unlikely to be huge, it may still be significant.

OmniVision’s new testing facility in Shanghai should lower costs of production, and speed product delivery.

OmniVision has consistently beaten analyst expectations for EPS. There is evidence to suggest that this trend will continue, and current estimates will be beaten; the most recent analyst initiation calls for EPS of 2.21 for FY 2005, well above consensus of 1.91. This is a positive indication for the likely actual EPS, since analyst initiations are usually well informed (better informed than updates, since more research is generally put into an initiation than an update). Also, the initiation is likely more accurately predictive than prior initiations since the information used is more current.

Analyst consensus EPS for the next FY have risen from 1.34 to 1.94 over the past 90 days; this is a significant positive for the stock, as changes in analyst EPS expectations for growth stocks are a useful predictor of stock-price changes.

The most recent analyst initiation also contained the highest price target for the stock-$83 per share. (Note: This is not a split-adjusted price, the stock will split soon.)

We expect significant stock-price appreciation over the next 6 months, after which time we would re-evaluate the company.

The realization (or lack of) benefits from recent cost-reduction and operational efficiency initiatives will be an important measure of management ability to continue to position the company for long-term competitiveness.

Changes in Omnivision’s share will be a major measure of the value that their products add to customers.

The development of OmniVision’s new markets, and its portion of them will help signal timelines and define reasonable expectations for long-term results from the company.

Volume for the stock is neutral, suggesting that further consolidation may occur with significant volatility before the next upside move.

Picture taken from SwingTracker, my real-time charting software.

OVTI currently exhibits no convincing bullish or bearish patterns. However, if the stock were to decline below 52, it would complete a bearish head and shoulders pattern.

Picture taken from SwingTracker, my real-time charting software.

In the short term, OVTI generally tracks the Nasdaq quite closely, although with a higher beta. (OVTI undergoes larger percentage swings than the Nasdaq, but in the same direction.) However, this trend has recently decayed, with the Nasdaq having made new relative highs, while OVTI has lagged. We expect that this is a result of OVTI’s earlier earnings-induced breakout drawing a fickle momentum crowd into the stock, and that the traders are now divesting themselves of OVTI. This divergence is likely to be repaired.

Long-term chart of the Nasdaq and OVTI:

Picture taken from SwingTracker, my real-time charting software.

Short-term chart of the Nasdaq and OVTI:

Picture taken from SwingTracker, my real-time charting software.

Buy: Market. We want exposure to the stock, as we expect it to outperform. Furthermore, we feel that this is a good entry point, as it is near to uptrending support (the head and shoulders neckline).

Stop loss: We will stop out of half the position at $51.94 per share, just below the last major upside pivot point drawn along the head and shoulders neckline.

Target: Our target for the stock is at slightly over 40x next year's consensus earnings estimates. Specifically, at $79.45 per share.