To The Moon

$Adobe(ADBE)$

Adobe I see it as a buying opportunity at its current price, given that it’s down over 26% in the past year, or if it’s more of a value trap and we should wait for a lower level before considering it. That’s exactly what I’ll discuss today.

To be upfront, I’ve been more bearish than bullish on Adobe previously. Many of you know me for being honest and transparent—I’m not one to sugarcoat things or lean bullish just to avoid disagreement. Unlike some other that always take a positive stance on stocks to appease their audience, I tell it like it is. If I don’t like a stock, I’ll say so, and Adobe has been no exception.

Earning Overview

That said, Adobe is an incredible company with a dominant position in multiple niche markets. Its product suite, like the widely used PDF platform, is impressive, and its business model is exceptional. In its last earnings report, Adobe showed strong numbers: revenue up 11%, earnings per share up 177%, and operating cash flow up 83% year-over-year. Despite these positive results, the stock still declined due to its guidance missing analysts’ expectations by a slight margin.

Fundamental Analysis

At the time, Adobe was priced to perfection, which left little room for error. Now, the stock has become more reasonably priced, which changes the investment case. Historically, overvalued tech stocks like Adobe can experience significant corrections after any disappointment, as we’ve seen with companies like Netflix.

The positives for Adobe include its subscription-based revenue model, which accounts for over 93% of its total revenue, ensuring predictable and high-margin earnings. Its operating efficiency is commendable, with low expenses primarily in sales and marketing, and it boasts a solid balance sheet with a net positive cash position. Additionally, Adobe's margins are stellar, with a net income margin of 38%—even higher than Microsoft’s—and a return on capital above 38%. This is undeniably a remarkable business model.

Strong Fundamentals Adobe's subscription-based business model generates consistent revenue, with over 93% of its revenue being recurring. This provides predictability and resilience. The company's high margins (net income margin ~38%) and strong cash flow position make it financially robust.

Guidance

Adobe's guidance for fiscal year 2025, as mentioned, includes a projected revenue range of $5.63 billion to $5.68 billion. This guidance fell slightly below analysts’ expectations, which were set at $5.73 billion. While the difference is relatively minor, it still caused a reaction in the stock price, primarily because the stock was previously priced for perfection.

It's worth noting that the slight miss in guidance reflects conservative projections rather than a significant decline in business fundamentals. However, given Adobe's prior valuation, even small deviations can lead to notable stock price corrections.

Free Cash Flow

Adobe has provided revenue guidance for fiscal year 2025, projecting between $23.3 billion and $23.55 billion. While specific free cash flow (FCF) projections for 2025 have not been disclosed, analysts estimate that with consistent FCF margins around 36%, Adobe's FCF could reach approximately $8.6 billion in 2025.

It's important to note that Adobe's FCF calculations can be influenced by factors such as stock-based compensation (SBC). Some analyses suggest that conventional FCF calculations may be misleading if SBC is not accounted for, as it can significantly impact the company's cash flow.

Technical Analysis

The technical analysis suggests that Adobe's stock is currently in a bearish phase, with key indicators pointing to potential further declines. However, the proximity to oversold conditions, as indicated by the RSI, may lead to a consolidation or reversal if the stock finds support at the aforementioned levels.

Support and Resistance Levels:

Support Levels: Current support around $440, aligning with a trendline connecting the September 2023 swing low and recent trading activity. Approximately $475, near the June 2023 pullback low corresponding to consolidation periods in June 2023 and June 2024.

Resistance Levels: Initial resistance at $500, near multiple peaks and troughs since September last year. Further resistance around $635, aligning with a double top formed between December 2023 and February.

Risks and Challenges

However, no stock is perfect, and Adobe has its challenges. One notable issue occurred recently when customers discovered they could cancel and renew their subscriptions to receive a significant discount, costing the company millions. While this may seem minor, it raises questions about demand and pricing strategy.

Another concern is the growing competition from AI. Many AI tools are encroaching on Adobe’s territory, particularly in areas like marketing content creation and design. While Adobe remains a leader, this trend is worth monitoring as AI continues to evolve and potentially capture more market share over the next five years.

Valuation Risk Adobe has historically traded at high valuation multiples due to its strong market position and growth prospects. However, any slowdown in growth or failure to meet market expectations could lead to significant multiple compression, as seen in past price corrections.

Guidance Shortfall Adobe’s fiscal 2025 revenue guidance ($23.3B–$23.55B) came in below Wall Street expectations, raising concerns about its growth trajectory. Any future guidance that disappoints the market could lead to further declines in stock price.

Valuation

Valuation-wise, Adobe trades at 22x forward non-GAAP earnings, which is reasonable compared to its historical averages. However, factoring in stock-based compensation, the GAAP P/E is closer to 28x, making the stock less cheap than it might initially appear. Even at 22x, Adobe isn’t overpriced, considering its recurring revenue and cash flow strength, but I wouldn’t expect significant multiple expansion from here. At best, I anticipate annual returns of 12-14%, in line with its expected EPS growth.

After a 26% decline in the stock price over the past year, Adobe's valuation appears more reasonable to some investors. The forward P/E ratio of 22x (non-GAAP) is now closer to industry averages.

Market sentiment

Adobe’s core markets, including creative software and digital marketing, may be approaching saturation. This could limit growth opportunities, especially in mature markets. Stock-Based Compensation (SBC) Adobe’s high SBC levels have been a point of contention, with some investors concerned about its impact on cash flow and shareholder dilution.

Pricing Concerns reports of customers exploiting subscription discounts have raised questions about Adobe’s pricing power and the sustainability of its revenue model.

Short-Term Traders: Short-term sentiment remains bearish, with traders focusing on technical indicators and broader market conditions.

Market sentiment around Adobe is cautiously neutral, leaning slightly bearish in the short term due to technical trends and guidance concerns. However, the company's strong fundamentals and proactive AI adoption keep long-term optimism alive among many investors.

Conclusion

To sum up, Adobe is a solid buy for those who believe in its long-term prospects and are comfortable with moderate returns. Personally, I’m not compelled to buy Adobe right now, as I see better opportunities in the market, particularly with companies that have stronger long-term tailwinds. While Adobe is a great company, the risks posed by AI and the lack of significant growth catalysts make me hesitant. That’s my honest take. If you’re passionate about Adobe, it could be worth buying at this level, but for me, it’s not a priority.

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