Why Adobe Systems Incorporated (ADBE) Stock Will Keep on Truckin’

It was only a few years ago that investors were wondering whether Adobe Systems Incorporated (NASDAQ:ADBE) was in a long-term decline. Photoshop and Flash seemed likely to be victims of the shift away from desktop usage. Adobe earnings plunged in FY2013 and declined again in fiscal 2014. ADBE stock looked like dead money.

Why Adobe Systems Incorporated (ADBE) Stock Will Keep on Truckin'

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Adobe stock looks very different now, however. ADBE has almost quadrupled in the last five years.

Photoshop and the company’s Document segment overall have flattened out, as predicted. But success in Adobe’s Marketing Cloud and Digital Media has led Adobe earnings and ADBE stock steadily higher.

There’s no reason to expect a change in ADBE stock coming out of the first quarter release, due Thursday. Expectations are high, to be sure. But Adobe earnings have beaten those expectations for four straight quarters. Q1 results seem likely to drive a fifth straight beat.

Adobe Earnings: Expect Growth

Again, expectations are high coming into Adobe earnings for the first quarter. Wall Street consensus suggests a 19% increase in revenue and further expansion in margins. Earnings-per-share are expected to rise 30%, to $0.87 from $0.66.

But if that seems like a tall order, bear in mind that both are relatively in line with ADBE earnings and sales guidance after Q4. (Analysts are expecting a bit higher revenue growth, with guidance suggesting an ~18% increase.) And of late, Adobe has had no problem beating its guidance — and Street estimates.

Both FY15 earnings above $2 and FY16 earnings above $3 (both non-GAAP) exceeded the company’s long-term targets laid out after fiscal 2013. In FY16, Adobe earnings beat consensus — handily — in each of the last four quarters, helping drive further gains in ADBE stock.

While the absolute growth rates sound high, estimates actually suggest a deceleration from fiscal 2016 results. Revenue increased 22% last year, with EPS rising nearly 50%. With continued cloud adoption boosting both sales and margins, there’s little reason to see much of a slowdown in fiscal 2017. That should lead to Q1 numbers looking solid — and likely further gains for Adobe stock.

Potential Catalysts for ADBE Stock

Headline numbers aside, the Adobe earnings release will have more information on the company’s cloud transition. What has been impressive about Adobe is that cloud adoption has driven higher overall sales.

Unlike, say, Microsoft Corporation (NASDAQ:MSFT), where cloud versions of Office are just cannibalizing product sales, ADBE’s overall top line is growing. The company’s ARR (annualized recurring revenue), a direct measure of strength in cloud services, will be a closely watched metric in Q1.

One point of concern on that front might be questions about whether ARR is going to hit a ceiling soon. That figure already represented nearly two-thirds of Adobe revenue in fiscal 2016. If investors worry about potential diminishing returns in that initiative, ADBE stock could struggle coming out of earnings.

In addition, Marketing Cloud results will be closely watched, as that’s the one area where Adobe isn’t a dominant leader. Its Photoshop and Acrobat businesses have little in the way of competition, but cloud-based marketing is a tougher field.

Adobe is going against major competition: Salesforce.com, Inc. (NYSE:CRM), Oracle Corporation (NYSE:ORCL) and International Business Machines Corp. (NYSE:IBM), among others. If Adobe shows that it’s taking further market share in that business, there’s really nothing to stop further growth — and further gains for ADBE stock.

Finally, operating expenses may be closely watched as well. While margins and earnings have improved steadily, some bears on Adobe stock have pointed to rising spend as a possible problem once revenue growth slows down. For now, those investments in sales and G&A are bearing fruit. But Adobe will need to show disciplined growth.

How to Play Adobe Stock Into Earnings

I’m not sure ADBE represents an ideal earnings trade. Expectations are high: Cowen & Co. upgraded Adobe stock to a Buy, with a $140 price target just this past Friday. The market might shrug off a modest earnings beat, given the performance over the last two years, in particular.

There’s no reason to bet against ADBE stock, however. The nature of the cloud model makes earnings relatively predictable (as a large portion of revenue is under contract). That would seem to leave little room for an earnings miss.

From a longer-term perspective, Adobe stock still has more room to run. Valuation isn’t that high, with the stock trading around 31x FY17 guidance plus its nearly $4 per share in cash. Against ~25% EPS growth, that valuation is far from ridiculous. A dividend probably is on the way soon (Adobe already is buying back stock).

The Marketing Cloud business, in particular, can cement the bull case. A business with 30%+ operating margins and three dominant franchises is always going to get a bid from investors. And Q1 earnings seem likely to only strengthen that case.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2017/03/adobe-systems-incorporated-adbe-stock-keep-truckin/.

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