Before Buying OmniVision, Look Both Ways

NEW YORK ( TheStreet) -- Since reporting fiscal first-quarter earnings results that disappointed the Street, shares of OmniVision ( OVTI), which were already in a downtrend, have lost another 17%.

Understandably, OmniVision bulls insist that the stock is oversold, while "observers" are debating whether to take a closer "peek" at a possible turnaround candidate.

Although the valuation does look interesting here, I would be careful about catching -- what might prove to be -- a falling knife.

This is not the first time this company has taken some bruises. While OmniVision, which has a strong position in the image-sensor market, has benefited from its ties to Apple ( AAPL), the company has also experienced some volatile price swings. After this recent selloff, it's anyone's guess where this stock is heading next, especially in light of what I believe was a decent quarter.

First things first: Given the weakness we have seen in mobile handset shipments, that OmniVision was able to grow revenue by close to 45% year over year was pretty impressive. Plus, the fact that revenue advanced 11% sequentially amid a low ASP, or average selling price, environment was equally remarkable. Unfortunately though, OmniVision still didn't do enough to please the Street -- which had modeled for an extra 2% to 5% growth (according to some estimates).

Now, for a little more context, consider that Qualcomm ( QCOM), which is the leader among semiconductors in the mobile/wireless business, is coming off a quarter during which revenue advanced 35% year over year. In the same category, Broadcom ( BRCM) just posted 7% revenue growth, which fell short of Street estimates by nearly 10%. Yet, neither Qualcomm nor Broadcom have seen their stocks erode to the degree of OmniVision. This is even though all three companies are dealing with the same fears of high-end mobile device saturation.

By that logic, investors are betting that OmniVision's 17% decline in the stock was an overreaction. It very well may be. But there's one key difference.

As has been the case for quite some time, OmniVision continues to suffer from weak leverage. Also, profitability hasn't always been strong, which explains the company's history of volatility.

Again this quarter, gross margins, which declined by almost 2% year over year, reminded analysts of just how competitive OmniVision's market has become. Not to mention, management didn't help matters by issuing guidance that was more than 7% below estimates, effectively confirming reasons for the panic.

Now, I do understand that management didn't want to set expectations too high and set the company up to fail. But it's worth asking if OmniVision's relationship with Apple is as strong as previously perceived?

To be fair, I don't have sufficient data to model how much revenue growth OmniVision should generate from Apple's recent launch of the iPhone 5S and the 5C. But looking back at OminiVision's fiscal second-quarter of 2013 (November quarter 2012), the company posted an almost 80% jump in revenue, helped (in part) by a 62% increase in device shipments. What I also know is that, OmniVision's second-quarter performance followed Apple's launch of the original iPhone 5 and the iPad mini last September.

But understand, I'm not suggesting that OmniVision is guaranteed to have a blowout quarter. Nor am I suggesting that management has no clue what it's doing. But I do see several catalysts to suspect that management may be low-balling guidance just a bit, especially if Apple announces a deal with China Mobile ( CHL).

The other thing to consider is that, Avago ( AVGO), which is another Apple supplier, recently raised guidance -- presumably, in anticipation of better-than-expected demand from the iPhone launch. So far, both the iPhone 5S and 5C have received better-than-expected reviews, relative to the initial downbeat response by the Street.

What this means is that there is no clear answer as to what OminiVision's management might be thinking. However, from a pure valuation play, I do see a possible bounce in the stock from the 17% decline. And if Apple does contribute to a recovery in ASPs, which would then dispel fears of high-end device saturation, OminiVision stock can head back toward the $18 to $20 range.

But let me remind you of the volatile nature of this company. I would suggest you look both ways before crossing that bridge.

At the time of publication, the author was long AAPL.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Richard Saintvilus is a co-founder of StockSaints.com where he serves as CEO and editor-in-chief. After 20 years in the IT industry, including 5 years as a high school computer teacher, Saintvilus decided his second act would be as a stock analyst - bringing logic from an investor's point of view. His goal is to remove the complicated aspect of investing and present it to readers in a way that makes sense.

His background in engineering has provided him with strong analytical skills. That, along with 15 years of trading and investing, has given him the tools needed to assess equities and appraise value. Richard is a Warren Buffett disciple who bases investment decisions on the quality of a company's management, growth aspects, return on equity, and price-to-earnings ratio.

His work has been featured on CNBC, Yahoo! Finance, MSN Money, Forbes, Motley Fool and numerous other outlets.