PSB Monthly Issue April 2009

| April 7, 2009

April 2009


Don’t tell me you’re still using your cell phone just to talk to people.  If so, you’re falling behind the times.

Today more and more people are using their cell phones (now called smart phones) to check email, listen to music, watch videos, and surf the web.  Gone are the days when cell phones were used simply for talking or texting.

These “must have” gizmos are the cutting edge of technological innovation.

Skyrocketing demand for smart phones is driving demand for another important technology – digital signal processors (DSP).

DSPs are the foundation of the digital revolution.  They power the communication and multimedia functions in a number of devices.

You’ll find them at the heart of smart phones, cell phones, portable multimedia devices, camcorders, and digital cameras.  They’re also widely used in digital DVD/DVR devices, HDTVs, set top boxes, and hard disk drives.

TDSPs convert an analog signal (such as the human voice, music, or video) into digital form.  Digital signals offer better sound quality than analog, and they can handle data as well as voice.

A dilemma for semiconductor manufacturers.

Growing demand for electronic devices with greater connectivity, portability, and capability is putting pressure on semiconductor manufacturers.  They must make smaller, more feature-rich integrated circuits offering better reliability, lower cost, and greater performance.  This is becoming more and more difficult given shorter product lifecycles and greater battery power constraints.

A design gap emerges.

Semiconductor manufacturing processes have made long strides in recent years.  Many more circuits can be placed on a single chip than ever before.  The problem is design capabilities have not kept pace with the advances in manufacturing.  As a result, a growing “design gap” has emerged between greater manufacturing potential and restrained design capabilities.

Stand alone DSPs don’t get the job done.

More and more manufacturers are abandoning the traditional approach of using stand alone DSPs.  The need for more complex designs makes it near impossible for most semiconductor manufacturers to develop the necessary technology in-house.  And, shorter design cycles (due to shorter product lifecycles) make it no longer cost efficient.

Instead, they’re turning to a silicon intellectual property company that offers a brilliant solution to their problem.

This amazing company provides cutting edge DSP intellectual property which addresses the manufacturers’ design gap.  With this company’s technology, manufacturers can create their own DSP designs and tailor them for their unique products.  Best of all, they can do it cost efficiently.

This silicon intellectual property company is none other than San Jose, California basedCEVA, Inc. (CEVA).

Key Investment Data

Name:  CEVA, Inc.
Ticker Symbol:  CEVA
Market Cap:  $153 Million
Recent Price:  $7.85

PSB Rating System 4.7 Stars

Raging Revenue: (4.8 stars) Revenue jumped 22% last year. Lucrative royalty revenue skyrocketed 58% to a record $14.3 million.

Beautiful Books: (4.8 stars) Gross profit last year totaled $35.7 million on mind boggling margins of 88%. Earnings per share rocketed 113% higher to $0.32.

Stellar Structure: (4.2 stars) Insider ownership is respectable at 8% but could be higher. Institutions own 82% of the float. CEVA repurchased 554,000 shares last year at an average price of $7.50 per share.

Valuation Verification: (4.5 stars) CEVA is trading at a 25% discount to its growth rate based on next year’s earnings estimate. The shares offer a potential gain of 89% to our price target of $14.85.

Meaningful Milestones: (5.0 stars) Over 300 million chips with CEVA’s technology were shipped last year. More than one billion CEVA powered chipsets exist worldwide. The company now has a 61% share of the licensable DSP market.


CEVA is the leading licensor of silicon intellectual property platform solutions and DSP cores to the semiconductor industry.

They design programmable DSP cores, DSP-based subsystems, and application specific platforms.  They also develop software which enables the rapid design of DSP-based chipsets or application specific solutions for developing a wide variety of applications.  (I know this sounds complicated, but bear with me.)

CEVA’s programmable DSP cores offer a range of cost, power efficiency and performance points.  Their DSP-based subsystems are the essential hardware components integrated with the DSP core to form the system on a chip design.  And, their portfolio of application platforms includes multimedia, audio, Voice over Packet (VoP), Bluetooth, and Serial ATA (SATA).

Semiconductor manufacturers incorporate CEVA’s intellectual property into application-specific chipsets or custom-designed chipsets.  They then sell these chipsets to consumer electronics companies, which incorporate them into a variety of end products.

Here’s the key, over a billion CEVA-powered chipsets are now deployed worldwide.

They’re used in wireless handsets, portable audio devices, digital cameras, camcorders, digital TVs, and TV set top boxes.  (You might own a device with CEVA technology inside and not even know it.)  CEVA’s DSP technology is also used extensively in developing the next generation of wireless handsets and portable multimedia players, including the revolutionary portable video players.

CEVA’s business model is absolutely ingenious.

They develop cutting edge technology and patent it.  Instead of manufacturing the actual chipsets, they provide their technology to semiconductor manufacturers and original equipment manufacturers.  These manufacturers in turn pay licensing fees to CEVA for access to this technology.

But, here’s the truly ingenious part of the business model.

CEVA collects a royalty on every chip incorporating their technology.  These royalties are usually a percentage of the chip’s sales price.

Over 300 million chips were made last year using CEVA’s DSPs.  This number is increasing every year as more and more manufacturers incorporate CEVA’s technology into their products.  You can see how these royalties could drive CEVA’s profitability into the stratosphere for years to come.

Aside from its profitability, CEVA’s business model offers other advantages.

By not manufacturing the actual chips, CEVA avoids having to invest billions of dollars in factories, equipment, and workers.  This translates into sky high profit margins. They’re also able to focus their resources on research and development.  This is important because they need to stay on the cutting edge of technological innovation.

CEVA’s growing customer base is a tremendous asset.

Their customer list reads like a who’s who of the technology sector, including Broadcom, Nintendo, Nokia, Samsung, Sharp, and Sony Ericsson.  An impressive eight of the top ten wireless handset makers utilize CEVA’s technology.

Through extensive licensing, CEVA now has a worldwide community developing CEVA-based solutions.  CEVA can leverage their strengths, customer relationships, proprietary technology advantages, and existing sales and marketing infrastructure.

More important, system OEM companies can now obtain CEVA-based chips from a wide range of suppliers.  This reduces their dependence on any one supplier and fosters greater price competition.  Greater competition helps contain the cost of CEVA-based products allowing them to expand their market share.

It’s no wonder CEVA DSP cores are fast becoming the DSP-of-choice in the embedded DSP market.


2008 was a great year for CEVA.

CEVA’s DSP technology is fast becoming the standard in the industry.  307 million CEVA powered chips were shipped last year despite the weak economy.  A 36% increase over the prior year’s shipments.  CEVA’s market share now stands at a dominating 61%.

Total revenue jumped 22% to $40.4 million.

Licensing revenue rose a respectable 11% to $21.7 million as the company added 30 new licensing agreements.  But, even more impressive are the gains made in more profitable royalty revenue.  These increased by a whopping 58% to a record $14.3 million.

For a glimpse of CEVA’s future profit potential look no further than their gross profit margins.

On revenue of $40.4 million, CEVA’s gross profits were an amazing $35.7 million.  This translates to mind boggling gross profit margins of 88%.  About double the average gross profit margin in the industry.

Net income jumped 118% to $6.7 million.  Earnings per share rocketed 113% higher to $0.32.  Very few companies are showing this kind of spectacular earnings growth in our present economy.

An immaculate balance sheet puts CEVA in strong financial position.

No need to worry about CEVA’s ability to weather the economic downturn.  Last year the company generated $8.3 million in net positive cash flow.  They ended the year with almost $85 million in cash ($4.33 per share) and no debt.

Management is busy creating shareholder value.

In the fourth quarter, CEVA repurchased approximately 554,000 shares at an average price of $7.50 per share.  The company also recently adopted a new plan for repurchasing up to 196,000 shares this year.

The outlook for 2009 and 2010…

Revenue and earnings estimates for 2009 are roughly flat with 2008.  Sales of wireless handsets are expected to taper off after last year’s huge growth spurt.  We view lowered expectations as a good thing.  They provide an opportunity for CEVA to post upside surprises.  (Surprises can cause the stock price to really jump.)

Look for CEVA to return to its longer term growth rates in 2010.  Revenue and earnings are expected to grow 11% and 38% respectively over 2009 estimates.


Every investment carries some risk and CEVA is no exception.

One risk is the company’s reliance on its five largest customers for a significant portion of its revenue.  Future revenue growth depends on attracting new customers and expanding relationships with existing customers.

Another risk is continued market acceptance of CEVA’s licensable intellectual property business model.  CEVA’s future growth depends on the trend away from in-house development of DSP’s, toward licensing open DSP cores continuing.

A third risk is the global economic downturn’s potential negative impact on CEVA’s royalty revenue.  If the recession causes demand for consumer electronic devices to keep falling, CEVA’s royalty revenue could suffer.


We’re recommending CEVA based on the company’s strong growth outlook.  The company is projected to grow earnings by 25% per year over the next five years.  We don’t believe this estimate is overly aggressive (even with the current global economic downturn).

The key to CEVA’s high growth rate is their royalty revenue.

Remember, CEVA receives a royalty payment for every chip incorporating their technologies.  And, revenue from these royalties is growing very fast.  Royalty revenue jumped 58% in 2008 from 2007 and has rocketed up an amazing 127% since 2006.

These numbers are great, but they’re just the beginning.

Only 13% of all wireless handsets shipped globally last year incorporated CEVA’s technologies.  We think CEVA is poised to expand its share of this lucrative market as consumers migrate toward 3G handsets.

3G handsets are the cutting edge of the wireless handset market and its fastest growing segment.  Shipments of 3G handsets are expected to jump from 39% of all handset shipments last year to more than 50% this year.  And, they’re expected to account for more than two-thirds of all shipments by 2013.

CEVA stands to grab a large share of this market as three of the largest 3G chip suppliers use CEVA’s DSP technology.

A comparison with two larger competitors shows CEVA offers huge potential upside.

CEVA’s earnings are expected to grow much faster than Texas Instruments (TXN) and Qualcomm (QCOM).  But, its stock trades at a much lower price relative to its projected earnings growth.  Given its higher growth rate, CEVA deserves a higher P/E multiple.

With a conservative PEG Ratio of 1.50, CEVA’s P/E would be 38x.  Assuming CEVA’s fiscal 2009 earnings meet estimates of $0.29 per share, a P/E of 38x implies a share price of $11.02 (a potential gain of 40%).

Because CEVA operates in a high growth market, investors may soon start factoring next year’s earnings estimate into its stock price.  A P/E of 38x next year’s earnings estimate of $0.40 implies a stock price of $15.20 (a potential gain of 94%).

A price to book analysis yields an even higher price target for CEVA.  The average P/B ratio for TXN and QCOM is about 3x.  CEVA’s book value per share is $6.23.  Applying a P/B of 3x, CEVA’s shares are worth $18.69 (a potential gain of nearly 138%).

Our analysis puts CEVA at $14.85, a gain of 89% or more from its recent price.


BUY CEVA, Inc. (CEVA) up to $9.00.

Recent price is $7.85.

Use a stop-loss of $3.93 on this position.

Don’t forget your position sizing and stop-loss rules.



Is the big bad bear finally dead?  The market’s ongoing rally certainly suggests it is. After falling through decade old lows, the Dow is up more than 1,500 points or 24% in the past month.  A 20% rise in the Dow often signals the beginning of a new bull market.

But, don’t get your hopes up just yet.

Sudden rallies of 10% to 20% are common in bear markets.  They happen so often, we even have a name for them – “Bear Market Rallies”.

After a big decline, buyers will usually step in and buy as stocks appear extremely cheap.  This causes the shorts to cover their positions.  These two forces combine to drive the market up very quickly.  Eventually, the buying runs out of steam.  And, the bear trend resumes for another leg down to retest the prior low.

We recently saw a perfect example of a bear market rally.


The Dow rose almost 20% from November 20th to January 2nd.  But then, the rally gave out and the index fell 28% to a twelve year low in March.

The current rally looks like a typical bear market rally.

The Dow is up 24% off the March lows in just four weeks time.  But, it’s not rising on fundamentals.  It’s rising on the growing belief the government’s fixed the financial system.  There’s also hope the recession will end this year.

I believe the market is going through a lengthy bottoming process that is far from over.  We will have to get through more bad economic data and corporate earnings before we’re through.  This points to the market heading lower again to retest the November lows and quite possibly the even lower March lows.

That’s why I’m recommending a defensive stock in this month’s issue.

It’s good to have a few defensive stocks in your portfolio when times are tough.  They usually don’t fall as much during a bear market as economically sensitive stocks.  And, they’ll often provide a nice return when most other stocks are falling.

What are defensive stocks?

These are stocks of companies that make things people buy no matter how bad the economy gets.  Things like food, beverages, alcohol, and cigarettes to name a few.

The downside to defensive stocks is they usually have low growth rates.  This means they tend to underperform growth stocks when times are good.

Now, if you can find a defensive stock that also has strong growth potential, you’ve really found a hidden gem.  And, that’s what we have with Overhill Farms (OFI).

Key Investment Data

Name:  Overhill Farms
Ticker Symbol:  OFI
Market Cap:  $60 Million
Recent Price:  $3.84

PSB Rating System 4.5 Stars

Raging Revenue: (4.0 stars) Revenue jumped 24% to a record $238 million last year. 30 new private label products introduced at Safeway should help boost revenue this year.

Beautiful Books: (4.4 stars) Net Income rocketed 124% higher last year to a record $10.3 million. Expanding gross profit margins should boost profits this year. Earnings are expected to grow 16% a year over the next 5 years.

Stellar Structure: (4.5 stars) Insider ownership of 12% indicates confidence in OFI’s future. With just 55% ownership, institutions have plenty of room to expand their holdings and drive the stock higher.

Valuation Verification: (4.8 stars) OFI offers huge upside potential of 100% to 200% from its recent price. The stock’s recent price ignores OFI’s strong growth potential.

Meaningful Milestones: (4.8 stars) OFI had record revenue and income in 2008 despite the terrible economy.


Overhill Farms is a leading manufacturer of high quality, prepared frozen food products. They make entrees, plated meals, bulk-packed meal components, pastas, soups, sauces, poultry, meat and fish specialties, as well as organic and vegetarian offerings. They sell their products to branded retail, private label, food service, and airline customers.

OFI has been making quality frozen food products for 35 years.

You’ve probably eaten their products without even knowing it.  If you’ve ever purchased a Safeway brand product, flown American Airlines, eaten at Panda Express, or tried the Jenny Craig weight loss program, you’ve had a delicious meal prepared by Overhill Farms.

But, what’s so special about this company?

They offer a convenient one-stop solution for frozen food production.

Customers can outsource the entire manufacturing process to OFI.  They handle everything from product development to final packaging.  Customers benefit by getting products to market faster.  And, they avoid having to make a huge investment in manufacturing resources and equipment.

Let’s take a closer look at OFI’s production process.

It all starts with OFI’s top notch research and development team.

Over the years, the R&D Team has developed an extensive product line based on time tested conventional recipes.  But, they’re not content to rest on their laurels.  This R&D Team is continually developing new recipes to meet ever changing consumer tastes.  And, when conventional won’t do, they’ll develop custom products based on the customer’s unique specifications.

Then it’s off to the manufacturing facility.

OFI’s 225,000 square foot, state-of-the-art manufacturing facility is ready to tackle most any job.  They can manufacture products based on OFI’s extensive catalogue of recipes or the customer’s specifications.

Either way, customers get a high quality product.

OFI fully inspects, tests, and monitors every product they make to ensure it meets the company’s high standards.  The company’s built a solid reputation for quality over the last 35 years and they work diligently to protect it.

OFI may offer a quality product, but they’re not the only game in town.

There are many firms in the frozen food production business.  Customers choose among them based on price, food safety, product quality, flexibility, product development, customer service, and name recognition.  OFI is very competitive on each of these factors.

And, as a smaller, more nimble company, OFI has an advantage over their larger competition.

They’re able to produce mid-sized to large custom product runs within a short time frame.  Best of all, they can do this on a cost-effective basis for the customer.

Now, let’s take a look at their financial situation.


2008 was a very good year for OFI.

Revenue jumped 24% to a record $238.8 million.  Higher sales to H.J. Heinz (up 145%) and Safeway (up 80%) were a big help.  The company also began exclusive production of frozen entrees under the popular Eating Right™ and O Organics™ brands.

2009 revenue should get a nice boost from 30 new private label products introduced at Safeway in the fourth quarter.  (These products are flying off the shelves.)

Gross profit increased 47% to $29.3 million.  Margins increased from 10.3% of net revenue to 12.3%.  The increase came from higher sales, greater manufacturing efficiency, and modest price increases.

OFI expects margins to expand further in 2009.

Lower raw material prices and increased sales prices should drive the expansion.  The company is also replacing a number of lower margin accounts with new higher margin accounts.

Earnings are growing rapidly as well.

Net income more than doubled to a record $10.3 million or $0.65 per diluted share from $4.6 million or $0.29 per diluted share in 2007.

All in all, a very good year indeed.

OFI’s Chairman, President, and CEO, James Rudis, summed up the year nicely when he said, “…our fiscal 2008 results… reflect improvement in virtually all areas of operations… [which] enabled us to do very well under conditions that have been a challenge to companies in our industry.”

The company did note one challenge it faces in 2009.

H.J. Heinz is pulling about $19 million in food production away from OFI and moving it in-house.  The good news is OFI has replaced the lost Heinz business with $20 million in new business.

The company’s strong financial performance is continuing so far in 2009.

For the first quarter of fiscal 2009, net income popped 56% to $2.5 million or $0.16 per diluted share.  Revenue declined slightly to $55.3 million due to the weak economy.

Gross profit margins increased to 13.6% from 10.5% a year ago.  Expanding margins indicate OFI is continuing to improve manufacturing efficiency and pass along price increases to customers.

Management is cautiously optimistic for 2009.

CEO, James Rudis, said “…opportunities remain strong for new business, both from new customers and from additional products and volume from existing customers.” Management expects revenue to be flat with last year and earnings to grow 11%. Pretty good considering most companies’ revenue and earnings are projected to fall this year.

And, let’s not forget the balance sheet.

OFI has plenty of cash and liquidity to cover current working capital needs and future growth initiatives.  They’re also deleveraging by paying down long-term debt.  Best of all, shareholder equity has doubled in the past year.


Our analysis of OFI wouldn’t be complete without a look at a few of the risks.

One risk is the potential impact from the economic slowdown.  Management believes customers will keep their inventories leaner and hold off on new product launches in the near term.  However, they fully expect order volumes and product introductions to normalize over the course of the year.

Another risk is OFI’s reliance on a few large customers for more than half its revenue. The loss of any of these customers would hurt OFI if they failed to add new customers to offset the lost business.

A third risk is a substantial increase in commodity prices.  If commodity prices jump, it could hurt OFI’s profitability.  The company hedges against price increases and will raise prices if necessary to recover the increased cost of raw materials.


We like OFI for three reasons.  It’s defensive.  It has strong growth potential.  And, its stock price is misvalued.

Given the weak economy, we like the fact OFI does business in a defensive industry. Everybody has to eat even if times are tough.  And, consumers are likely to gravitate toward OFI’s comparatively less expensive products in order to save money.

Earnings are expected to grow 11% this year, 18% next year, and 16% a year over the next five years.  These growth rates are much higher than those of its two larger competitors.  Consistent earnings growth should drive OFI’s stock higher and higher.

Finally, the market’s misvaluation of the stock at recent prices offers huge potential returns.  A comparison with two larger competitors shows just how misvalued the stock really is.

OFI’s forward P/E ratio is ridiculously low at just 4.5x.

With faster growing earnings, you’d expect OFI’s forward P/E to be at least as high as its competitors.  A forward P/E of 11x 2009 estimated earnings of $0.72 per share puts OFI’s stock price at $7.92.  A potential gain of 106% from recent levels.

A PEG ratio analysis yields an even higher price for OFI.

With a PEG ratio of just 0.33, OFI is trading at a huge discount to its higher earnings growth rate.  A conservative PEG Ratio of 1.0 implies a P/E of 16x and a stock price of $11.52.  About 200% higher than its recent price!

My analysis puts OFI at $9.72 – that’s a potential return of 153%.


BUY Overhill Farms (OFI) up to $4.86.

Recent price is $3.84.

Use a stop loss of $1.92 on this position.

Don’t forget your position sizing and stop-loss rules.


Category: PSB Monthly Issues

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