RealMoney Silver - OmniVision Comes Into Focus

OmniVision Comes Into Focus
By Bill Trent
RealMoney.com Contributor
3/18/2008 1:52 PM EDT

Since reporting blowout earnings in late February, digital-camera-chip maker OmniVision Technologies (OVTI) has been on a tear. OmniVision makes CMOS sensors, which are used in digital cameras and cell phones.

After bottoming out in the low teens for much of the first two months of 2008, the rally has taken the shares above their 200-day moving average, thanks to support from upward analyst revisions.

After a recent fresh look, I am encouraged by improving earnings quality and the potential for renewed interest as value investors begin to focus on rising free cash flow due to a drop in capital expenditures.

With $6 per share in cash, OmniVision's operations are being valued at just $12 a share. And at $18, shares trade at just 11 times fiscal 2009 EPS estimates. Analysts expect the company to earn $1.68 in the fiscal year ending April 2009. These estimates are "non-GAAP" earnings and exclude stock option compensation expense. Since "GAAP" stands for "generally accepted accounting principles," I consider non-GAAP to be unacceptable accounting.

OmniVision

Click here for larger image.

Source: Zacks Research Wizard;
compiled by William A. Trent

Not surprisingly, when I check OmniVision's accrual ratio, I find that cash earnings and reported earnings tend to diverge pretty widely. However, the trend has been showing some improvement over the last couple of quarters, which could support a bullish thesis.

Still, adjusting back the option expense and excluding interest income, the operating earnings per share still look to be around $1 a share -- making for a still-reasonable price of 12 times earnings -- when cash is excluded form the stock price.

Cash from operations over the last 12 months was $88 million ($76 million adjusted for after-tax interest income) and capital expenditures were $62 million. The resulting 2.3% free cash flow yield is not great, but it isn't bad if it represents a cyclical low.

Indeed, the capital expenditures in the April 2007 quarter accounted for two-thirds of the total expenditures and represented the tail end of a significant investment in new equipment. On a more normalized basis, free cash flow would be about $50 million, amounting to a hefty 8% free cash flow yield. As the expenditures anniversary with the next earnings report, it is quite possible that many cash-flow-oriented value investors will begin to spot OVTI on their screens.

Cause for Concern

However, OmniVision derives 70%-80% of sales are derived from the camera cell phone market. Recent trends in the handset market suggest there could be some bumps in the road ahead. Handsets have been selling like hotcakes, but recent cooling signs have emerged.

In a tougher handset market, I'd also expect a tougher pricing environment for OmniVision and its peers. Competitors in the market for CMOS image sensors include MagnaChip, Micron (MU) , Samsung, Sony (SNE) , ST Microelectronics (STM) and Toshiba. The company also faces competition from the makers of CCD chips, which have typically represented the higher-end products.

Still, I like the recent trend in OmniVision and the potential for expanded interest among value investors in coming months. With appropriate protection (such as tight trading stops), it might be worth taking a risk in the name.

Alternatively, the April $17.50 puts are $0.80 as I write this. Writing the puts would offer either a 4.5% five-week yield on the money risked, or a more attractive entry point of $16.70 should the options be exercised.