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Should You Buy the Dip In This Top Automotive Chip Company?

Ready or not, autonomous driving car features are coming. Starting with model year 2024, Nvidia's (NASDAQ: NVDA) DRIVE Orin chip and sensor system will be available for use among automakers. But there are other ways to play the development of vehicle autonomy. One of them is small chip designer Ambarella (NASDAQ: AMBA).

After more than doubling its stock price over the last three years (which includes the recent 60%-plus sell-off from all-time highs), Ambarella is putting up solid numbers as its computer vision chips find their way into more automaker technology designs. Is it time to buy the dip?

Image source: Getty Images.

A fierce sell-off on a great rebound story

Let's start with some definitions of what Ambarella does. Nvidia has designed an entire system for self-driving car technology, from individual chips that compute data while a car is driving all the way to the cloud computing that trains the software to drive the car. By contrast, Ambarella is far more specialized. It develops a specific type of chip for "computer vision" (where the CV in the company's CVflow chip family comes from).

If you've been sniffing around Ambarella long enough, perhaps you remember it as the company that made vision chips powering GoPro's (NASDAQ: GPRO) action cameras. Turns out hitching a wagon to a niche consumer market could only take the company so far. Back in the mid-2010s, Ambarella embarked on a mission to diversify its business into much more reliable enterprise uses as the GoPro craze fizzled. Now Ambarella sells circuitry designs for things like security cameras, industrial IoT and robotics, and, of course, auto technology.

These days, Ambarella's chipsets combine image and video processing with AI processors that help a vehicle or computer system not just "see," but also to make sense of what's on the road.

For a point of reference, Ambarella's computer vision technology is moving in the same direction Tesla (NASDAQ: TSLA) has decided to go with its self-driving vehicle capabilities (although Tesla is not a known customer because it has its own proprietary platform). Nvidia's system makes use of a combination of vision, radar, and LiDAR (which uses lasers to sense its surroundings).

After working hard on new uses for its chips, Ambarella achieved a new revenue record last year (fiscal year 2022 for the company, the 12-month period ended Jan. 31). Sales were $332 million, a 49% year-over-year increase after a tough first year of the pandemic and exceeding the previous full-year sales record of $316 million all the way back in fiscal year 2016.

Big opportunity, but tough market conditions

Ambarella's vision chips have huge potential -- both in vehicles and in lots of other industrial uses as businesses around the world look for ways to automate workflows and get more efficient. The company believes it has reached a key inflection point in its development roadmap. Its CV chips were about 25% of total chip revenue in the last year, with the other 75% composed of more basic video processing hardware. At its investor day last November, management said it thinks 45% of revenue will be CV chips this year (fiscal 2023).

Put into more specific terms, Ambarella thinks revenue in the current quarter (Q1 fiscal 2023) will be $88.5 million to $91.5 million, an increase of 26% at the low end of guidance. And as these more advanced semiconductors make up more of the revenue mix, margins should improve too. Management called for adjusted gross profit margin on products sold to be 63% to 64% in Q1, compared to 62.9% last year.

Ambarella's workforce is predominantly focused on developing software that makes its chips easier to implement (manufacturing of actual chips is handled by fab partners like Samsung). This is a great business model, one that has worked wonders for the likes of Nvidia and the innovation it's been able to coax out of its video game GPUs (which are now powering data centers as computing accelerators).

But here's the rub: Even after a steep tumble from all-time highs, Ambarella is no cheap stock. It trades for seven times one-year forward expected sales, and the company intentionally operates at close to nil free cash flow (just $21 million generated in the last year) as it funnels profits back into research and development.

With the Federal Reserve gearing up for interest rate hikes this year to fight inflation, Ambarella stock is likely to be highly volatile, since higher rates lower the present value of stocks, especially growth stocks that generate little profit. Any slowdown in sales growth (perhaps if the current global chip shortage starts to ease) is also likely to be met with shareholder angst. In other words, this is an incredibly promising company if you believe in vehicle autonomy and AI in general, but current market conditions have me on hold at the moment.

Still, Ambarella deserves attention after the progress it's made in CV chips in recent years. Keep this semiconductor name on your watchlist.

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Nicholas Rossolillo and his clients own Nvidia and Tesla. The Motley Fool owns and recommends Nvidia and Tesla. The Motley Fool has a disclosure policy.


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