Why Ambarella Inc (AMBA) Stock Will Not Keep Bouncing Back

Ambarella Inc (NASDAQ:AMBA) stock dropped. Big time. And now it’s rebounding. Strongly. AMBA stock kicked off September trading with a 22% drubbing. The company reported better than expected second quarter numbers, but delivered a disappointing guide which pointed to continued weakness in the once all-important drone and action camera markets. Wall Street responded with a flurry of downgrades and price target reductions. Investors sold in droves.

AMBA Stock

But the selling didn’t last long.

AMBA stock is up more than 20% over the past month. Investors have apparently shaken off the negative drone-related news and instead taken a positive outlook on the company’s growth potential with its new computer vision chip.

Is too late to join in on this rally?

I think so. I peg the fair value of AMBA stock around $50, which is exactly where the stock is trading today.

Why AMBA Stock Tanked

The current growth narrative at AMBA is the same one that has been taking hold over the past several quarters.

Action camera sales are down due to continued weakness at GoPro Inc (NASDAQ:GPRO). Drone sales are tallying off due to weakness from Tier 2 customers, and there isn’t any inflection point in sight because market leader DJI didn’t use AMBA solution for its recently launched Spark drone. Weakness in these markets is being offset by robust growth in the security, home monitoring and automotive markets.

Overall, revenues are up, but gross margins are down (lower margin product mix). Gross margin deleverage is more than offsetting revenue growth, Consequently earnings growth is negative.

But revenue growth is expected to turn sharply negative in the third quarter due to bigger-than-expected headwinds in the drone market. The virtual reality market is also off to a slower than expected start. These headwinds are expected to persist for the full-year. Management now sees revenue growth being negative this year (versus flat growth prior).

Negative earnings growth coupled with gross margin compression and operating expense deleverage implies a free-fall for earnings. So AMBA stock sold-off, because investors were uncertain when earnings would find a bottom and where that bottom would be.

Why Ambarella Stock Rebounded

AMBA stock has rebounded because the drone and action camera markets aren’t really the future for this company. The future is all about the computer vision market.

All eyes have turned to CV1, Ambarella’s first computer vision chip which is the culmination of 4 years of work. Computer vision represents a step up from the company’s current areas of expertise, which include image processing and video compression. CV essentially adds an artificial intelligence component in the mix, so now Ambarella is a part of the whole automated technologies discussion.

Bulls have a lot of reason to be excited about CV1. One, computer vision is a huge growth market. The market is expected to grow roughly 33% per year into 2022. Two, Ambarella has established itself as a market leader in image processing and video compression. It seems only natural that Ambarella leverages its technological capability to become a market leader in computer vision. Three, dedicated solutions for computer vision are currently few in number, meaning AMBA could benefit from early mover’s advantage.

For all these reasons, AMBA stock has rebounded off its $40 to low to trade right around $50. The move higher makes sense given the huge computer vision growth opportunity, so AMBA doesn’t look like a good short candidate here. But is it worth buying?

Bottom Line on AMBA Stock

I don’t think AMBA stock is worth chasing here. I like the growth story, but I think the stock is appropriately valued considering uncertainty related to future revenue and earnings growth potential.

CV revenue is going to take a while to show up in any material way on the income statement, and when it does show up, it’s tough to say how much of the market AMBA captures. Competitors like NVIDIA Corporation (NASDAQ:NVDA) and Advanced Micro Devices, Inc. (NASDAQ:AMD) are sure to up their games in this space over the next several quarters.

That is why earnings estimates in 3 years sit at just $2 per share. That means AMBA stock is trading at 25-times earnings that are 3 years out. That isn’t a terribly attractive multiple, especially considering post-2019 growth is anything but a sure thing.

Overall, I think AMBA is a high-single digit revenue grower and mid-single digit earnings grower over the next several years. Paying 26-times forward earnings for mid-single digit earnings growth just seems too pricey.

As of this writing, Luke Lango was long NVDA.


Article printed from InvestorPlace Media, https://investorplace.com/2017/10/amba-stock-bouncing-back/.

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