Are Brighter Days Ahead for Ambarella?

Ambarella's (AMBA 3.18%) stock plunged 40% last year due to ongoing concerns about the chipmaker's decelerating sales growth, competition from bigger chipmakers, and contracting margins. However, the stock rebounded about 30% this year as some investors saw glimmers of hope for a longer-term recovery.

Are the bulls or bears right about Ambarella's future? Let's examine its recent headwinds and tailwinds to find out.

Image source: Getty Images.

What happened to Ambarella?

Ambarella produces image processing SoCs (system on chips) for action cameras, dash cams, security cameras, drones, and other devices.

It once generated most of its revenue from GoPro (GPRO -1.12%), but waning demand for GoPro's cameras, GoPro's use of non-Ambarella SoCs, and Ambarella's diversification into other markets reduced GoPro's weight to an "immaterial" percentage of its sales last year.

However, Ambarella's other major customers, including drone leader DJI Innovations and security camera leader Hikvision, also pivoted away from the chipmaker with alternative SoCs. Both DJI and Hikvision started ordering chipsets from Intel's (INTC 0.64%) Movidius, which adds AI-powered computer vision features to its image processing SoCs.

Intel also owns Mobileye, the largest supplier of ADAS (advanced driver assistance systems) in the world. It also produces EyeQ computer vision chips for driverless cars. The combination of Mobileye's EyeQ chips, Movidius' Myriad chips, and Intel's own Atom CPUs gives it plenty of ways to render Ambarella's core business of image processing SoCs obsolete.

To counter Intel, Ambarella launched its CV series of computer vision chips for driverless cars and partnered with ADAS software provider Hella and driver monitoring system (DMS) maker Smart Eye. It also continues to launch high-end image processing chipsets like its new S6LM SoC for security cameras, which merges advanced image processing, low power consumption, and cybersecurity features into a single package.

Image source: Ambarella.

Approaching an inflection point?

Ambarella's revenue fell 23% in fiscal 2019 (which ended on Jan. 31), compared to a 5% decline in 2018. That decline was mainly attributed to weak demand for its image processing SoCs in the consumer electronics (action cameras and drones) markets. However, sales of its automotive and security camera SoCs still rose by the "single digits". 

But if we look at Ambarella's revenue declines on a quarterly basis, we'll see that those declines are bottoming out:

YOY = Year-over-year. Source: Ambarella quarterly reports.

For the first quarter of 2020, Ambarella expects its revenue to decline about 17% annually. It didn't provide any full-year guidance, but Wall Street expects its revenue to decline just 7%.

However, Ambarella's gross margins are still contracting as it pivots away from the higher-margin consumer electronics market and relies more on sales of its lower-margin security camera SoCs in China.

Non-GAAP basis. Source: Ambarella quarterly reports.

Those declines won't end anytime soon. Ambarella expects its non-GAAP gross margin to decline to 59%-60% in the first quarter of 2020. It also expects its non-GAAP operating expenses to rise from $29.5 million in the fourth quarter to $30.5-$32.5 million in the first quarter due to the ongoing expansion of its CV chip business.

Ambarella didn't provide any earnings guidance, but analysts expect its non-GAAP earnings to tumble 92% this year before rebounding in fiscal 2021. That's a dismal outlook for a stock that trades at more than 70 times forward earnings.

Are brighter days ahead?

Ambarella's business is expanding into new markets, and it's gradually reducing its dependence on fickle consumer electronics companies. However, it still relies heavily on the lower-margin security camera SoC market and the sluggish automotive market, and its CV chips face stiff competition from Intel.

I might consider buying Ambarella as a turnaround play if the stock were cheaper, but its high forward P/E indicates that there's still too much growth priced in. I've never been a fan of Ambarella, and I think investors who chase its latest rally could get burned.