Adobe Inc

-1.13 (-0.25%)
: $527.81 +69.07 (+15.06%)
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The Impact of Adobe's Spectacular Pivot



Adobe stock is hitting new highs and there's good reason for it. The fundamentals are very strong and the company has made a massive pivot into subscription based software. It took some time for the transition to finally "work" but as of Q1 2015, 72% of the company's revenue is from recurring sources, up from 50% in Q1 2014.

Adobe has two strong legs to stand on, the first is called "Creative Cloud" which is it is software subscription based business. Subscribers have grown from 1.8 million in Q1 2014 to 3.5 million by the end of 2014. Last quarter the company reported ~530,000 additional subscribers which was below the estimate of ~580,000 and the first time the company realized a slowing of growth in raw numbers (Q4 2014 showed 644,000 new subscribers). But, it's still growing like gang busters.

The second leg is Adobe's Marketing Cloud, which generated revenue of nearly $1.2 billion in 2014 and is expected to grow by 25% annually for the next three years. The digital marketing space is enormous, and according to the Motley Fool, "IDC predicts the global marketing software market will expand by 50% through 2018, rising to $32.8 billion."

In total, ADBE has successfully made a painful but wonderful pivot and there is reason to be bullish on the stock, even though growth numbers may be slowing. ADBE's revenue (TTM) is trending higher (it has risen for more than five consecutive quarters) while operating margins, net income and free cash flow are all rising.

The average estimate for next quarter's revenue of $1,210.2 million is above last quarter's $1,162.2 million.

Technicals | Support: 77.91 | Resistance: 83.94    

Golden Cross Alert:
The 50-day MA is now above the 200-day MA.
Swing Golden Cross Alert: The short-term 10 day MA is now above the 50 day MA.

ADBE has a five bull (top rated) technical rating because it's trading above its 10-, 50-and 200- day moving averages and the stock is up on the day.

Here are the consensus estimates for next quarter. Note that last quarter's actual result is included at the far right.
Earnings Date EPS Revenue (Mean) Revenue (Median) Last Quarter (Actual)
2015-09-15 $0.36 $1,210.2 M $1,207.7 M $1,162.2 M Provided by ZACKS

Let's look at the core elements that drive the company's fundamental rating.

Fundamentals Rating Summary

Revenue (TTM US$ Millions) 4,350 4,105 4,252

Operating Margin (QTR) 1.200 1.14 1.16 RISING

Net Income (TTM US$ Millions) 365 284 565 RISING

Levered Free Cash Flow (TTM US$ Millions) 1,180 1,009 924 RISING

Research and Development (US$ Millions) 208 209 203 FALLING

Research and Development Expense/Revenue 0.179 0.196 0.201 FALLING

Stock Returns and Chart

ADBE is up +11.1% over the last three months and up +9.8% over the last six months. The stock price is up +13.1% over the last year.

Before we dig into the fundamental trends that drive the rating, let's look at a two-year stock chart with regression channel and 10-day momentum (on the bottom).
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Now let's examine the visualizations of the critical financial measures.

Revenue (TTM US$ Millions) 4,3504,1054,252

Revenue (TTM) is trending higher meaning that it has increased for at least five consecutive quarters. We can see n the revenue chart below how ADBE faced a serious challenge with this pivot into a subscription based model and is still not quite at all-time highs in revenue. But, the growth is back, the model is working and revenue is the proof in the pudding.

What do all these numbers mean?
ADBE's fundamental rating benefited these results:
1. The one-year change was positive (but no extra points were given for a large percentage increase).
2. The two-year change was positive.
Finally, the up trend (consecutive quarters) in revenue benefited the fundamental (star) rating.

Let's look at Revenue (TTM US$ Millions) in the chart below.

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Operating Revenues/Operating Expense 1.2001.141.16RISING

Operating revenue over operating expense simply shows us how much revenue (in dollars) is generated for every dollar of expense. We can see again that obvious and abrupt drop in core fundamentals as the firm shifted (pivoted) its business model. But we can also see the powerful trend back up. I'll repeat it yet again, the pivot is working. The ratio must be (at a minimum) above 1.0 in order for a company to turn an operating profit. For the latest quarter ADBE showed a ratio of 1.20 up from 1.14 a year ago. We can also see in the chart below that ADBE assets are now at all-time highs.

What do all these numbers mean?
A year ago Operating Revenues/Operating Expense was 1.14. In the last year we can see operating margins are increasing and are also currently greater than 1.0 (the critical level).

ADBE's fundamental rating was affected from the operating margin numbers in two ways:
1. The current value is above 1.0 (the firm generates an operating profit).
2. The one-year change was positive (raises the rating).

Let's look at Operating Revenues/Operating Expense in the chart below with the total assets in the orange line.

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Net Income (TTM US$ Millions) 365284565RISING

Net Income (after tax profit) over the trailing twelve months (TTM) for ADBE is rising and has followed the same trend as revenue and operating margins. It was hurt during the transition and is making a strong move up now that the pivot is in full swing. For the most recent trailing-twelve-months (TTM) the company reported net income of $365 million which is a 29% rise year-over-year.

In our next chart we plot Net Income (TTM US$ Millions) in the blue bars and the quarterly results in the gold line. Note the rising tide for both metrics.

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Levered Free Cash Flow (TTM US$ Millions) 1,1801,009924RISING

Levered Free Cash Flow (FCF) (TTM US$ Millions) is a critical determinant of stock price since market cap is the present value of all future free cash flows. FCF looks just like net income, in that it has finally turned around with the company's change and is nearing an all-time high. We can see 17% growth year-over-year and a very clear upward trend.

For our next chart we plot Levered Free Cash Flow (TTM US$ Millions) in the blue bars through time.

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Adobe made a big bet on changing its business model to one that is subscription based. That bet cost the company in the short-term, but is paying off big time right now and the future looks quite bright. While growth forecasts may change and the risk in those changes are non-trivial, ADBE is in the midst of a powerful fundamental turn around which is reflected in the stock price, revenue, earnings, margins and free cash flow. The company is a leader in one of the biggest new markets (digital marketing industry) and is capitalizing on over a decade of software development and customer acquisition. In this current market there is a high premium paid for growth and an equally high price paid for missing that growth. But, taking a less myopic view, ADBE is doing everything right in an industry that is hyper competitive.