Better Buy: Ambarella, Inc. vs. Advanced Micro Devices

Image sources: Ambarella, Advanced Micro Devices.

Of all the chip stocks our market has to offer, arguably no two well-known names could be in quite as different a position as video processing chip specialist Ambarella (AMBA -1.30%) and graphics chip company Advanced Micro Devices (AMD -1.81%). But these two companies also have more in common than you might think.

But before we get there, I can't help wondering: Which is the better buy today?

Has Ambarella hit bottom?

On one hand, Ambarella stock has fallen nearly 50% over the past year and sits more than 70% below its 52-week-high, given ongoing weakness in its core wearable-camera segment. Most recently, Ambarella shares plunged more than 7% in a single day last week, after key customer GoPro (GPRO -3.30%) told investors that revenue in its most recent quarter declined a whopping 49.5% from the same year-ago period. Putting aside the fact that the decline was better than GoPro expected, Ambarella's guilt by association seemed fair enough at first glance; GoPro has previously represented as much as 30% of Ambarella's total revenue, so it stands to reason that Ambarella should continue to suffer as long as the action camera maker's sales remain depressed. 

As I researched the biggest threats to Ambarella for an article last month, however, I realized this concern might prove unfounded. Recall, for example, that during its most recent earnings conference call two months ago, Ambarella management revealed that GoPro's high inventories had already caused demand from GoPro to decline to the low-single-digit range as a percentage of overall revenue. As a result, Ambarella opted to take a conservative approach in accounting for wearables revenue in issuing guidance -- which calls for revenue to decline in the range of 24% to 20% year over year for the current quarter -- despite what management described as "strong sales" from supplemental markets, including IP security, automotive aftermarket, home monitoring, and flying cameras.

For perspective, that disappointing guidance was the primary reason Ambarella shares also plunged after the company's quarterly report in March. As such, it appears to me that Ambarella's latest GoPro-induced decline was nothing more than a knee-jerk reaction that had already been priced in after the company's latest outlook. If Ambarella's other markets continue to show promise as it diversifies away from the wearable market -- and keeping in mind that wearables could see a rebound if GoPro introduces its new HERO 5 camera line in time for the holidays -- Ambarella could be poised for a fast and furious rebound.

Will AMD keep winning?

On the other hand, Advanced Micro Devices stock is up nearly 60% over the past year, driven most recently by a 38% single-day pop two weeks ago on the heels of the company's better-than-expected first-quarter results.

But that's also not to say AMD's results were impressive on the surface. Similar to Ambarella's impending performance, AMD's revenue declined 19.2% in the first quarter, to $832 million, and resulted in an adjusted net loss of $96 million, or $0.12 per share. AMD management primarily blamed lower sales of semi-custom SoCs and client notebook processors for the declines, extending past concerns that had left the stock depressed in the first place. However, Wall Street was even less optimistic going in to the announcement, with analysts' consensus estimates predicting lower revenue of $818.2 million, and a wider adjusted loss of $0.13 per share. 

If that relative outperformance wasn't enough, AMD also revealed a new $293 million milestone-based agreement to license its processor and SoC technology to a newly created joint venture with China-based Tianjin Haiguang Advanced Technology Investment Co., Ltd., which will develop SoCs tailored to the Chinese Server market that serve to complement AMD's existing products. AMD also suggested it will receive additional royalties from the JV's future product sales.

In addition, AMD offered surprisingly strong guidance for revenue in the second quarter in the range of $931.8 million to $981.8 million, the midpoint of which represents modest year-over-year growth of 1.6%, and sat significantly higher than analysts' expectations for revenue to decline 5.6% year over year. For this, AMD management largely credited three new semi-custom SoC design wins -- a move many industry watchers see as a hint that AMD's semi-custom chips will appear once again in all three major gaming console providers' next-gen systems.

At the same time, however, I'm also unsettled that AMD still operates at a loss, even after adjusting for one-time items that tend to skew comparable results. By contrast, even as its sales remain under pressure, Ambarella has still managed to remain profitable on both a GAAP and adjusted basis. 

And as fellow Fool Tim Green pointed out recently, these deals alone won't be enough to push AMD into the black in the second half of this year, leaving some of the onus on taking back significant graphics-card share from NVIDIA. Considering NVIDIA just launched two new highly coveted gaming graphics cards based on its Pascal architecture this week, and last quarter commanded nearly 80% of the graphics card market in terms of units shipped, I fear this may prove too great a challenge for AMD to overcome. If that proves to be the case, AMD's recent jump could be short-lived.

So in the end, given what I believe is the market's overdone response to Ambarella's near-term struggles and the prospects of a turnaround, I'm convinced Ambarella is the better buy today.