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Adobe: Truly Unstoppable

GuruFocus.com

- By Ishan Majumdar

Design software is a space that has been relatively unhampered by the Covid-19 pandemic, and market leader Adobe Inc. (NASDAQ:ADBE) is no exception to the rule. The San Jose, California-based company has acquired a monopolistic position in the design software market with products such as Photoshop, Illustrator, InDesign, Dreamweaver, Flash, Acrobat, Fireworks and more. It has been among the few global companies to benefit significantly from the Covid-19 pandemic and has witnessed genuine tailwinds which have been evident in its past few results.


Financial results

Adobe reported yet another fantastic result for its third quarter of fiscal 2020, outperforming analyst expectations on both the revenue and the earnings front. The company delivered a top-line of $3.23 billion, which was well above the analyst consensus estimate of $3.16 billion and over 14% higher than the $2.83 billion reported in the corresponding quarter of the previous year.

In the words of the company's President and CEO Shantanu Narayen, this was the best Q3 result in the company's history. The growth was backed by a strong performance across all segments, particularly the Digital Media segment, which accounts for around 72% of Adobe's top-line.

The company's non-GAAP operating income was $1.40 billion and its non-GAAP earnings per share (EPS) of $2.57 was well above the analyst consensus estimate of $2.41.

Cash flow generation continued to be solid as the company generated $1.44 billion from operations.

The solid result prompted the management to be even more optimistic about the fourth quarter. They expect Adobe's revenues to rise to $3.35 billion in the fourth quarter with the non-GAAP earnings per share hitting $2.64. The biggest driver for this future growth is expected to be the company's Digital Media segment, which is expected to grow by 18% as per the management's outlook.

Digital media strength

The biggest driver of this strong quarter was the Digital Media segment, which grew by as much as 19% and accounted for around $2.34 billion of the top-line. Through this segment, Adobe provides a plethora of solutions that enable individuals and companies to create, publish, promote and eventually monetize various forms of digital content anywhere in the globe.

It is a loyal subscription customer base within the Digital Media segment which includes content creators, web application developers and digital media professionals. These customers generate a solid recurring revenue for Adobe each year. The annual recurring revenue (ARR) within this segment increased during Q3 2020 by as much as $458 million. Now, the Digital Media segment's ARR accounts for a total of $9.63 billion after the end of this quarter. It continues to be one of the strongest pillars of Adobe's growth for the future.

Strong tailwinds

The pandemic has resulted in a strong need to execute digital transformation among businesses across the globe, particularly traditionally-run businesses. The need for design and e-commerce services has increased and so has the overall necessity for companies to create a digital experience for its customers.

Adobe's suite of offerings has had a major role to play in such times and these factors have acted as strong tailwinds. Interestingly, none of Adobe's segments have been underperforming over the past quarter. Over and above the strong performance in Digital Media, the company also saw a 19% growth in the Creative revenue which rose to $1.96 billion. Its relatively smaller segment of Document Cloud generated $375 million in revenues and grew by 22% as well. The company's Digital Experience segment reported a revenue of $838 million, of which $729 million was subscription revenue, indicating 7% growth.

Adobe reported record web traffic on its home page and saw an increasing adoption of its creative cloud app as well as increased use of video and imaging software such as Photoshop and Lightroom. It is rare to find software players with such a strong performance across the board.

Final thoughts

Adobe: Truly Unstoppable
Adobe: Truly Unstoppable

As we can see in the above chart, Adobe's stock has gained 60% over the past six months, backed by two very strong quarterly results. The quarter also brought good news for yield investors as Adobe continued its share buybacks by repurchasing close to 1.5 million shares.

Adobe clearly is more of a growth play than a yield play as its buyback yield is nominal, but since the company is flush with cash, it is not a bad option to buy back shares and return money to the shareholders.

However, the stock is currently very pricey at an Enterprise-value-to-Ebitda multiple of 52.11 and a price-to-earnings ratio of 65.66, which are both well above the software industry average. The management is highly optimistic about a strong performance in Q4 as well. Thus, I think the best bet for current Adobe investors is to hold on to the stock, whereas investors looking to enter should keep it on the watchlist for now and wait for a price correction in the future.

Disclosure: No positions.

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This article first appeared on GuruFocus.