Ambarella (AMBA -3.78%) and NXP Semiconductors (NXPI 0.76%) are two under-the-radar chipmakers that tech investors might have overlooked in the recent rebound in semiconductor stocks. But over the past six months, Ambarella has rallied more than 20%, while NXP has bounced back nearly 10%. Do either of these stocks have more upside potential? Let's examine their core businesses, growth trajectories, and valuations to find out.

What do Ambarella and NXP sell?

Ambarella makes image processing SoCs (system on chips) for action cameras, security cameras, drones, dash cams, and other devices. The market leaders in many of these markets -- GoPro (GPRO -3.89%) in action cameras, DJI Innovations in drones, and Hikvision in surveillance products -- all use Ambarella's "best in breed" chips.

Image source: Ambarella.

Robust demand for these devices boosted Ambarella's revenue by 38.5% in fiscal 2015 and 44.9% in 2016. However, two major headwinds could throttle that growth this year. Demand for action cameras is slowing to a crawl, and competing SoCs from mobile chipmaker Qualcomm (QCOM -1.10%) and cheaper Chinese rivals could lure away major customers.

NXP sells a wide variety of chips for connected cars, security devices, and smartphones. After its acquisition of Freescale last year, it became the biggest manufacturer of automotive electronics in the world. It also supplies NFC (near field communication) chips to Apple (AAPL -1.72%) and Android device makers. NXP currently faces three major challenges -- the uncertain impact of Brexit on its European business, slowing sales of iPhones, and weaker-than-expected sales growth in its newly combined automotive chips business.

How fast are Ambarella and NXP growing?

Ambarella is a much smaller company than NXP, and generates most of its sales growth in the second half of the year due to heavier sales of action cameras and drones during the holiday season. NXP's sales growth is also lumpy due to the cyclical nature of auto and smartphone sales.


Sales Growth 4 Quarters Ago

Sales Growth 3 Quarters Ago

Sales Growth 2 Quarters Ago

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YOY sales growth. Source: Quarterly reports. *Adjusted to include Freescale's numbers.

Analysts expect Ambarella's revenue to fall nearly 3% this year but bounce back 19% next year. NXP's sales are expected to rise 56%, but that includes a big boost from the Freescale acquisition. After year-over-year comparisons normalize, analysts expect NXP to post just 6% sales growth next year.

Headwinds and tailwinds

As suppliers, Ambarella and NXP's sales growth in the rest of 2016 will rely heavily on how key customers fare. Ambarella has gradually reduced its dependence on GoPro over the past few quarters, but Pacific Crest estimates that the action camera maker's orders will still account for 25% of its sales this year.

Ambarella recently provided fairly upbeat guidance for the second half of the year, indicating that GoPro might win back customers with the Hero 5 and Karma drone during the holidays. But if those devices flop and some action camera and drone makers start using Qualcomm SoCs instead, Ambarella's sales could fall short of expectations.

Image source: GoPro.

NXP's acquisition of Freescale has reduced its dependence on Apple's iPhone, but it still needs decent sales of the iPhone 7 to strengthen its Secure Connected Devices business (which sells NFC chips), which accounted for 21% of its sales last quarter. It also needs global auto sales to keep rising -- which could be tough considering that sales in the U.S. and China have been pretty bumpy over the past two years.

Profits and valuations

Ambarella's non-GAAP net income plunged 52% annually to $11.4 million last quarter, mainly due to a 48% jump in R&D expenses. GAAP net income plunged from $18.9 million a year ago to just $1.8 million, which was mostly caused by its stock-based compensation more than doubling to $11.3 million. Looking ahead, analysts expect Ambarella to post a 28% decline in full-year earnings this year, which makes its forward P/E of 19 look a bit pricey, but earnings are expected to bounce back 22% next year.

NXP's non-GAAP net income improved 22% to $401 million last quarter, but its GAAP net loss widened from $107 million to $398 million, due to the acquisition of Freescale. Analysts expect NXP's earnings to rise just 1.8% this year but bounce back 31% next year, which makes its forward P/E of 11 look fairly cheap.

The winner: NXP

I think Ambarella and NXP both have their merits, but I personally prefer NXP because it has a more diversified portfolio, lower valuations, and isn't heavily exposed to unstable customers like GoPro or disruptive challengers like Qualcomm. NXP's position as the 800-pound gorilla in automotive chips also makes it a solid long-term play on driverless cars -- which could be a more reliable market than Ambarella's core markets of action cameras and drones.