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Ambarella Investors Seem to Be Missing a Big Red Flag

By Harsh Chauhan - Jun 9, 2019 at 8:47PM

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The U.S.-China trade war spells big trouble for this embattled chipmaker.

Ambarella (AMBA 0.25%) surprised Wall Street with a profit in the first quarter of fiscal 2020. The stock flew higher immediately after the announcement as investors were pleased with the chipmaker's performance in the face of the U.S.-China trade war.

But a closer look at Ambarella's latest performance and the accompanying guidance tells us that investors should not celebrate so much. Here's why.

Man covering his eyes with his hand.

Image Source: Getty Images.

Still struggling

Ambarella has failed to turn its business around since action camera maker GoPro decided to reduce its reliance on the chipmaker.

Ambarella's top line was down to $227 million in fiscal 2019, well below its initial expectation of $258 million in non-GoPro revenue. The company generated negligible revenue from GoPro last year, so the top-line weakness was a clear indication that its non-GoPro business has failed to take off.

The downtrend continued in the first quarter of fiscal 2020. Ambarella's revenue fell 17% year over year, and its net income fell to just $0.01 per share from $0.13 per share a year ago. The bottom-line performance, however, was way better than the loss of $0.05 per share that Wall Street was expecting. But this doesn't change the reality that Ambarella's financial performance took a massive beating.

What's more, the guidance failed to impress. Ambarella expects an 18% annual drop in revenue this quarter despite the company's claims that its computer vision (CV) chips are all set to gain more traction.

Ambarella expects to bring its second computer vision chip into mass production this quarter. The company also sees "three CV revenue waves taking shape," but there's one thing looming over all the potential.

Ambarella has a Chinese problem

Donald Trump's trade war with China is going to be a problem for Ambarella. According to the company's latest press release, "Recent order pull-ins from security camera customers in China, triggered by geopolitical factors, are impacting our revenue and gross margin."

This isn't surprising, because Ambarella relies substantially on Chinese companies such as Hikvision and Dahua. Bloomberg reports that each of these companies probably accounts for "a high-teens percentage" of the chipmaker's overall revenue.

It is expected that Hikvision and Dahua could be added to the U.S. government's Entity List. If that happens, Ambarella won't be able to conduct business with them, and this could spell big trouble. Investment banking firm Needham believes that the addition of Hikvision and Dahua to the Entity List could dent Ambarella's revenue to the tune of 25% to 30%.

But even if these two security camera manufacturers are not placed on the Entity List, another threat looms over Ambarella. China's Ministry of Finance has moved to increase tariffs on $60 billion worth of U.S. goods to as much as 25%, from the prior 10%. What's more, China has vowed that it will fight to the end in this trade war. As a result, Ambarella's chips might get more expensive. This could lead to further order reductions.

In light of all this, there are quite a few red flags that Ambarella investors need to watch. The company's top and bottom lines took a big hit last quarter, and the trend is expected to continue in the ongoing one. What's more, the U.S.-China trade war could drag on.

The company has already said that it is witnessing a cutback in orders from major security camera customers. Investors seem to be missing this crucial fact for now, but it could come back to bite the company and dent the stock's newly found momentum.

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