Ambarella (AMBA, Financial) has staged a very impressive rally over the last few months, as the stock is up over 70% since reporting its last quarterly earnings. Although Ambarella did report a good quarter, I think the rally may have gone too far and the stock is bound to retract considerably in the near future.
Declining Sales Growth
Throughout the prior few quarters, Ambarella’s sales were declining mainly due to the slashed demand for action cameras and rising competition from competitors offering less expensive products.
Moving ahead, consensus projects the company to post approximately 3% sales decline at the end of 2016, down considerably from 39% growth in FY15. Moreover, a few years ago, the company had a huge benefit in image processing SoCs, and successfully grasped a leading in the specific market.
This is the primary reason why drone king DJI Innovations, GoPro (GPRO, Financial) and Hikvision all use its SoCs. But, the story is changing day by day, as cheaper opponents have started gaining lead in the SoCs market. Throughout the previous few quarters, rising competition together with lower top-line and higher R&D expenses knocked its operating margin down.
In addition, Ambarella is heavily dependent on GoPro, as GoPro’s orders account for approximately 25% of the company’s sales. Ambarella has tried to diversify its revenue source by signing deals with other customers such as Xiaomi, however, it still relies heavily on GoPro and this trend is not expected to change any time soon. As a consequence of Ambarella’s over dependence on GoPro, it will likely suffer from GoPro’s deteriorating sales.
Qualcomm Is a Major Problem
Apart from the Chinese players, one of the most significant rivals of Ambarella is Qualcomm (QCOM, Financial). Qualcomm is putting in a lot of effort to grasp a robust position in the SoC market with the help of its mobile-based SoCs.
As a matter of fact, the most important benefit for Qualcomm is that it can integrate its 4G modems with the processors to allow OEMs manufactured drones or connected cameras, which do not required to be tethered to smartphones.
At present, various trivial action camera manufacturers use Qualcomm's SoCs in place of Ambarella's SoCs, and Qualcomm is desperately trying steal DJI Innovations and GoPro away from Ambarella. Given that Qualcomm can easily flex its financial muscle to push Ambarella out, I would not recommend buying the stock at these levels.
Conclusion
Ambarella has performed very well over the last three months, but its rally is about to come to an end. The current valuation has already baked in all the near-term tailwinds, and the risk/reward ratio is not favorable for new investors. As a result, I think Ambarella is a sell.
Disclosure: I don't hold a position in any of the stocks mentioned in the article.
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