Adobe Stock Forecast: Onwards and Upwards

This article was written by Talia Shakhnovsky, a Financial Analyst at I Know First.

“We’ve continued to see the momentum we saw in the first quarter. We continue to believe that as long as digital remains front and center, Adobe will do really well”
– Shantanu Narayen, Adobe CEO during CNBC interview

Summary:

  • Current fears of economic turbulence may be troublesome for the technology stock sector.
  • Within the software industry, Adobe is a leader in both revenue growth and earnings growth.
  • Adobe’s new applications, acquisitions of Magento and Marketo, and initiatives to broaden its consumer base are already causing further growth.
  • Adobe’s financial statement supports a long-term bullish outlook, with a potential share-price of $325 in one year’s time.
Adobe Logo – Source: Wikimedia

Market Trends: Fears of Economic Turbulence

While the United States is currently in its longest economic expansion, economic uncertainty is growing as well. On one hand, the market year-to-date performance on July 1st showed that the S&P 500 was up 17.35%, stocks had their best start in over twenty years, and the U.S. tallied its best six months for IPOs since 2014. On the other hand, pressure to cut interest rates is mounting due to increasing worries over trade and the global economy according to Federal Reserve chairman Jerome Powell.

These worries stem from both domestic and international developments. Within the United States, manufacturing dropped to a three year low in June. Moreover, while the US – China trade war has reached a ceasefire with a promise of no new tariffs during trade talks, US taxes on $250 billion in Chinese imports and China’s retaliatory measures remain. Most importantly, negotiations have not been able to resolve the fundamental issues that led to the trade war, stressing that existing tariffs are likely to remain in place for a long time, pressuring supply chains and global growth.

Adobe belongs to the technology stock sector – a sector vulnerable to global slowdown worries, like the ones occurring today. Adobe has long been an investor favorite, with its stock price increasing sevenfold from 2012 through the end of 2018 — six times more the S&P 500 Index. Although the technology sector is growing at its fastest rate in over seven years, interest rate cuts are likely and Goldman Sachs research that analyzed seven rate cutting cycles over thirty-five years found that while the S&P 500 climbed a median 14% over the year after a rate cut, the tech sector lagged by 13% – the worst performing sector in the index. Moreover, antitrust probes in the technology sector also threaten its growth. Adobe, however, can remain strong even if the technology sector undergoes difficulties due to its strong business developments, financial fundamentals, and lack of association with the trade war.

The sector with the biggest negative pre-announcement is technology, due to its central position in US & China trade developments – Source: CNBC

Adobe Competitive Position in Software Industry

Within the software-application industry, Adobe is a leader. According to CEO Shantanu Narayen, “Adobe is the absolute leader in content management…the leader in being able to create these mobile applications.” He explains that not only is Adobe the leader but is also the creator of both the digital marketing category and the customer experience management category. Furthermore, Narayen believes the development of AI will continue to aid Adobe because of the opportunity to participate in the global digital transformation. He elaborates that Adobe will become more and more successful “as long as [Adobe] can continue to make sure that we enable our enterprises to deliver that engaging experience, to use AI with all of the data that we’re collecting.” Thus, Adobe is on track to remain successful as a market leader even as technology changes.

Adobe’s growth rate and return also illustrate its success and economic importance within the software industry. Adobe had a higher growth rate than both the U.S. market and the software industry over a period of ninety days, three years, and five years. Adobe’s annual earnings growth rate also exceeded the Software Industry’s and the market’s annual earnings growth rate. Over larger time periods like five years, Adobe’s outperformance increases. Finally, Adobe’s annual revenue growth rate also exceeds both the industry and market rates of revenue growth. As a result, Adobe is not only a leader in products but is also a leader in financial growth.  

Adobe Growth Rate vs Software Industry for 90 days, 1 year, 3 years, and 5 years time periods.  – Source: Simply Wall Street
Adobe Earnings Growth Rate vs Software Industry vs Market for 1 year and 5 years time periods.  – Source: Simply Wall Street
Adobe Revenue Growth Rate vs Software Industry vs Market for 1-year time period.  – Source: Simply Wall Street

Adobe’s Business Growth Analysis

Adobe Inc. is a software company that was incorporated in 1997 and currently offers products in the Digital Media, Digital Experience, and Publishing segments. It utilizes application stores, its website, and direct sales to sell products through various cloud-based models such as software-as-a-service (SaaS). Adobe also utilizes term subscription and pay-per-use models. Currently, Adobe is a market leader[JTB1] : more than 90% of the world’s creative professionals use Photoshop, Adobe Creative Cloud mobile apps have over 150 million downloads, and more than ⅔ of Fortune 50 companies utilize Adobe Marketing Cloud. Adobe’s market share is significant in multiple segments: Adobe controls 2.67% of the market share in the Digital Marketing segment, 2.63% of the Digital Media Solutions segment, and 6.24% of the Print and Classic Publishing segment.  The company was even named the #1 computer software company in 2016 on Fortune’s list of the world’s most admired companies. Adobe is led by CEO Shantanu Narayen, who is currently in his eleventh year at the head of the company. In 2018, he was chosen as #12 for the Fortune Business Person of the Year list, and placed 5th in top US CEOs as chosen by employees with a 98% employee approval rating. As a result, Adobe has a track record of market success and consistent, high quality leadership.

On June 19th, 2019, Adobe released its Q2 Earnings Report. During the subsequent Adobe conference call with analysts,  CFO John Murphy analyzed Adobe’s growth drivers in Q2: “new user growth [was] driven by numerous global initiatives to generate demand, including targeted campaigns and promotions, … users coming to Creative Cloud through mobile apps and online engagement, and continued focus on new categories including immersive media and new segments such as social media creators.” He also pinpointed new subscriptions to the Creative Cloud Photography plan, Adobe Premiere Pro single app, and Creative Cloud enterprise as key sources of growth. Adobe’s growing digital media segment, where many of these initiatives were centered, showed a 22% year over year revenue increase to $1.89 billion, reaching nearly 70% of Adobe’s total sales. CEO Shantanu Narayen affirmed that Adobe has been pursuing growth by looking at platforms beyond print and web: Youtube, cars, mobile devices, augmented reality, and virtual reality. Finally, Narayen also described increasing their customer base as the source of Adobe’s growth: “Our number one focus is actually getting new people to the platform, …it’s new customer acquisition, it’s enterprise seed adoption, it’s international expansion that’s really driving the growth that we see.” Therefore, Adobe points to new customer acquisition initiatives as the fundamental source of recent growth.

During the analyst conference call, Narayen also mentioned Adobe’s recent acquisitions. One year ago, Adobe acquired digital commerce leader Magento for $1.68 billion, followed by a $4.76 billion acquisition of B2B company Marketo last October. Narayen explained that “the acquisitions of Magento and Marketo have significantly increased our value to existing customers, helped us attract new logos, and expanded Adobe’s addressable opportunity.” Magento contributes to the Experience Cloud by personalizing user experience, increasing shoppability, and attracting developers to Adobe. Acquiring Marketo furthered Adobe’s ability to provide a marketing engagement platform for B2B and B2C customers. Adobe has also recently embarked on a collaboration with Amazon. On May 14th, the company announced new Magento Commerce stores for Amazon sellers that run with Amazon Web Services to let sellers integrate their online presence with their storefront. As a result, Adobe has been utilizing its recent acquisitions to increase its user base, precipitating even further growth.

Finally, Adobe is developing new applications that are contributing to its positive trajectory. While Adobe is best known for Photoshop, other Adobe products include Premiere Rush which is now available on Android, in addition to iOS, Mac, and Windows. Narayen describes Premiere Rush as “the solution of choice for YouTubers and social video creators.” In May, Adobe released a major update to Adobe XD (a UX and UI design system) which allows teams to create and share designs. Moreover, the pro photo editing and management tool Lightroom is now available on the Mac App store – it’s the first pro Adobe app to make it to the app store since Apple redesigned MacOS. Lightroom offers a potential market for pro app subscriptions through the App store and utilizes new promotional features like tips and how-to articles to introduce new customers to Adobe’s software. The new Adobe fresco, an iPad painting app aimed at professional artists, aims to rival apps like Procreate with features unique to Adobe like automatically saving to the creative cloud, allowing artists to create on-the-go. Overall, Adobe’s new applications along with its business acquisition and customer acquisition strategy are paving the way for continuing success and growth.

Adobe’s recent acquisitions: Magento & Marketo  – Source: Magento, Marketo

Adobe’s Financial Position Analysis

Adobe’s financials highlight why Adobe is likely to be a bullish long-term investment. In Q2, Adobe reported record revenue. Adobe’s revenue rose 25.0% year-over-year to $2.74 billion in the second quarter, with earnings rising 10.3% to reach $1.83 billion. This increase exceeded analysts’ prior estimates of $2.7 billion for revenue and $1.78 billion for earnings. While deferred revenue decreased, CFO John Murphy states, “The sequential decline in deferred revenue was a result of timing rather than business performance due to fewer billing cycles in our second quarter. The impact was more than offset by an increase in unbilled backlog.” Deferred revenue is a key matric in calculating future revenue growth, and a decrease would normally indicate stalling momentum for subscribes. Adobe’s deferred revenue decline, however, is not significant because it is caused by billing-cycle timing, likely meaning a future quarter of slightly inflated deferred revenue growth. Additionally, Adobe’s net income increased, surpassing $900 million as opposed to $825 million in the same period just one year ago.

In the long run, share price tends to follow earnings per share. Thus, EPS growth is a positive indicator for long term investors. Adobe’s EPS has grown by 51% annually, over the last three years. This top-line growth indicates that Adobe’s growth is sustainable. Moreover, Adobe has been able to maintain stable EBIT (earnings before interest and taxation) margins over the last year, along with growing revenue. Adobe’s return has also surpassed the software industry for various indicators. For example, return on equity indicates how efficiently a company uses shareholder funds. Adobe’s return on equity was 27% versus the software industry average of 9.70%. Similarly, Adobe’s return on assets was 14% as opposed to the industry’s return of 6.1% and its return on capital over three years was 24% as opposed to the industry’s average return of 12%. Furthermore, Adobe’s balance sheet indicates that debt is not dangerous. It has a low level of unsold assets and debt is covered by operating cash flow and by short term assets (assets are 1.3 times debt). Interest payments on debt are also covered by earnings.

It is important to note that Adobe’s sales are climbing. Within the experience cloud division, which encompasses marketing, analytics, and e-commerce tools, sales grew by 34% to $784 million in the period ending May 31st, and sales are projected to grow the same percentage in the third quarter. The creative division including Photoshop grew 22% to $1.89 billion during the second quarter and is projected to increase by another 20% through August. Demand will likely remain steady because Adobe’s remaining performance obligation, which measures future revenue under contract, increased to $8.37 billion, compared to $8.13 billion at the end of the fiscal first quarter. CEO Shantanu Narayen summarizes the second quarter for Adobe by explaining, “We had a very strong quarter – over 400 million of ARR net new in Q2 which is a record for Q2. If you look at our targets for Q3, again in creative they would be a record 360 million…and so we believe that the momentum associated with what we’re doing…continues to propel the business.” Investors concur: after the release of the quarterly report, Adobe shares increased 4% in post-market trading.

Based on estimates from 27 analysts, Adobe earnings are expected to grow 19.4% annually, exceeding the low risk savings rate of 2.7% and US market average of 10%. Of the 31 analysts tracking Adobe in July, twenty-five have given it a “buy” rating, six have given it a “hold” rating, and none have given it a “sell” rating. The analysts 12-month median target price is $321.50, compared to the current price of $303.98. Following the quarterly report, Stephens analyst James Rutherford upgraded Adobe from “equal weight” to “overweight” because “the strong showing in digital media will help quiet any investor worries about a near-term slowdown in that business. …Based on our field work and the report last night, we have become convinced that the Marketo and Magento acquisitions will be material drivers of revenue growth in the near-term as that cross-selling motion heats up.” Consequently, various analysts have reached a bullish forecast for Adobe’s future.

Analyst recommendations for Adobe  – Source: Yahoo Finance

Conclusion: Adobe Valuation

Adobe is currently trading at $303.98 per share – near a 52-week market high and has been trading strongly over the course of the year, especially since the release of its Q2 earnings report. Considering Adobe’s dominance in digital marketing and customer experience management, Adobe is a good investment for the long run. CEO Shantanu Narayen is optimistic about Adobe’s future: “We love the position we’re in, we’re the clear leader.”

At a share price of $303.98 and 492 million outstanding shares, Adobe’s current value is $149.6B. Due to Adobe’s acquisition of Magento and Marketo along with its new products and market leader position, Adobe is likely to continue its upwards growth. 97% of Adobe’s total revenue comes from the sale of subscriptions to either the Creative Cloud (70%) or Adobe Experience Cloud (27%). Consequently, Adobe’s total revenue increases when its customer base increase (though selling more subscriptions). Growth in the Digital Media sector (Creative Cloud) from 2016-2018 averaged 26.7%, but Q1 and Q2 growth was lower at an average of 21.9% year-over-year and is a stronger indicator because of its recency. As a result, this segment’s revenue may increase by approximately 22% over the next year. Within the Digital Experience sector (Adobe Experience Cloud), segment revenue grew at 22.4% over 2016-2018, but was higher during Q1 and Q2, averaging 33.9% due to recent acquisitions in this sector. If the Digital Experience sector continues to grow at the same rate, it may increase by approximately 34% over the next year. Finally, the remaining 3% of Adobe’s revenue comes from its publication sector which only grew .1% from 2016-2018, so this sector’s revenue is likely to remain flat instead of growing. Based on the relative growth rates of Adobe’s sectors, its total revenue growth rate may approximately be modeled by 0.7*1.22 + 0.27 * 1.34 = 1.2158, or roughly 22% revenue growth over the next year to reach approximately $11 billion. With a net income margin of 25.5%, net income will be approximately $2.8 billion. Earnings per share equals net income divided by the number of shares – assuming number of shares stays consistent, Adobe’s EPS in a year may be 5.69. Finally, Adobe’s current PE ratio is 57.13 – estimated share price equals earnings per share times the PE ratio. In a year, Adobe’s share price may reach $325. Thus, I predict Adobe will continue its growth with an expected share price of $325 in one year, in accordance with I Know First’s bullish forecast.

Current I Know First Forecast

I Know First’s machine learning algorithm has a positive outlook for ADBE. The stock is bullish over the 1 month, 3 months and 1-year horizons. For the 1-year horizon, the signal is strongest at 314.35  with a predictability indicator of .65.

Past I Know First Success

On April 7, 2019 I Know First published a bullish forecast for ADBE. Since then, the stock price has risen 14.30%, highlighting another success of I Know First’s algorithm. 

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Please note-for trading decisions use the most recent forecast.