Here’s Why Investors Should Avoid Ambarella Stock for Now

The outlook for video chip developer Ambarella (NASDAQ:AMBA) is mixed for both the short-term and the long-term. With AMBA stock trading at a very high valuation, I would wait for a pullback of the shares and evidence of stronger execution by the company before pulling the trigger on a buy.

Here's Why Investors Should Avoid Ambarella Stock for Now
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In November, Ambarella reported better-than-expected third-quarter results. But much of the strength appears to have been driven by purchases of its security camera chips by Chinese customers who were adding to their inventories. Moreover, Ambarella provided Q4 revenue guidance that was above analysts’ average estimate. It’s entirely possible that the company’s Chinese customers relied more on their built-up inventories of the company’s products in Q4 than the chip maker expected. We’ll find out when Ambarella reports its Q4 results on March 3.

Further, two of Ambarella’s major Chinese customers — video surveillance device makers Hikvision and Dahua Technologywere added to a U.S. blacklist in October, because of their role in human rights violations in China’s Xinjiang region.

According to Barron’s, analysts estimate that those two customers account for 15%-25% of Ambarella’s total revenue. It’s possible that the blacklist had more of an impact on Ambarella’s results than the company had previously expected. Finally, the outbreak of the coronavirus from China may have had a negative impact on purchases by Ambarella’s customers.

Technology is Promising, but There are Questions

Ambarella’s CV chips are quite promising. By giving computers the ability to “see” objects, they would obviously greatly enhance security cameras, autonomous and semi-autonomous vehicles, and robots. Moreover, Ambarella says that, compared with competing technologies (principally LiDAR), its products are significantly cheaper, consume less power, and are easier to install. According to Ambarella, its chips also “provide much denser 3D distance measurements” and better “alignment with image data” than LiDAR.

Ambarella is making a great deal of progress selling its AI-enabled “computer vision (CV)” chips to security camera makers.  Nine out of the 10  major security-device makers that already buy chips from Ambarella are looking to buy its CV chips, too, Ambarella CEO Fermi Wang stated in December.  Wang added that he expects  to begin producing CV chips for “all nine” of those customers “sometime” this year, and he noted that production of the CV chips for two of the customers had already begun as of December.

However, it’s unclear as to when the company will begin recognizing revenue from its CV chip deals with security-device vendors. And Wang  reported that the company’s revenue from CV security cameras would be “more than 10%” of its total 2020 sales. So, particularly at the beginning of the year, it doesn’t seem like those chips will be a real game-changer for the company or for AMBA stock.

The outlook is much more cloudy when it comes to auto applications.  According to slides provided by the company for a presentation in December, Ambarella supplies non-CV chips to several of the world’s biggest automakers, including Honda (NYSE:HMC) and Toyota (NYSE:TM). But the only recognizable automaker listed as buying its CV chips is Mercedes-Benz.

It’s possible that Ambarella is in talks about selling its CV chips to most of the large automakers that buy its non-CV chips. It’s also possible that those automakers will start buying Ambarella’s CV chips once they start manufacturing semi-autonomous and autonomous vehicles on a large scale. But it’s also entirely possible that most large automakers have decided to stick with LiDAR technology simply because they’ve become used to it.

Bottom Line on  AMBA Stock

Ambarella’s AI-enabled chips have revolutionary potential, and they are apparently quite appealing to security-device makers. But the jury remains out on whether the company’s AI-enabled chips can gain a meaningful foothold in the auto sector.

Meanwhile, two of its major customers were placed on a blacklist by the U.S. government, and a number of its customers built up their inventories at the end of last year. Both of those dynamics make the company’s near-term outlook  uncertain. Finally, trading at 9.4 times the company’s sales of the last 12 months, the shares are actually quite expensive.

Given all of these points, I would not buy Ambarella’s shares ahead of its Q4 earnings. Instead, I recommend waiting for the stock to drop and for signs that it is successfully selling its CV chips to automakers.

Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015.  Among his highly successful, contrarian picks have been GE, solar stocks and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own shares of any of the aforementioned companies. 


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