Adobe Stock (NASDAQ:ADBE)
While the first-quarter earnings season is technically done, a few major reports are being released this week. Adobe (NASDAQ:ADBE), like Oracle (NASDAQ:ORCL), reports AMC on Thursday. A first glance at second-quarter earnings estimates suggests a possible trough in SPX per-share profitability. According to FactSet’s John Butters, the S&P 500’s anticipated EPS decline is -6.4%. If the quarter’s earnings decline is -6.4%, it will be the greatest reported by the index since Q2 2020 (-31.6%).
I’m starting coverage on Adobe with a hold because of its reasonable valuation and stretched technicals ahead of earnings later this week.
ADBE is a diversified software firm that provides electronic document technology and graphic content authoring products to creative professionals, designers, knowledge workers, high-end customers, developers, and corporations, according to Bank of America Global Research. Creative Suite, Photoshop, Acrobat, Premiere, Dreamweaver, Illustrator, InDesign, and LiveCycle are some of Adobe’s flagship products. The company’s PDF and Flash technologies have established industry standards and serve as a platform for other Adobe products.
According to The Wall Street Journal, the California-based $208 billion market cap Application Software industry firm within the Information Technology sector trades at a high 44.7 trailing 12-month GAAP price-to-earnings ratio and does not pay a dividend. The short interest in the legacy tech large cap is only 1.3% ahead of earnings on Thursday night.
Adobe posted an EPS beat in March, but top-line performance also exceeded Wall Street expectations. Revenue increased 9.4% year on year, and the company’s management team forecasted Q2 operating EPS in the $3.75 to $3.80 range. Overall, it was a strong quarter, with good operating leverage helping to drive profitability. The in-line projection for the current quarter contributes to a long-term optimistic view as it gains market share thanks to a rising Creative Cloud subscriber base and a solid user distribution channel.
More recently, Adobe stock rose following an upgrade from Wells Fargo analysts – AI was identified as a future earnings driver for the tech company. Sansei GenAI, ADBE’s own generative AI engine, was unveiled last week for its Adobe Experience Cloud products. With a promising future, there are hazards such as increased competition and a highly cyclical business.
According to BofA analysts, earnings will continue to rise at a rapid pace until 2023. The Bloomberg consensus forecast is roughly in line with what BofA predicts. While Adobe has a free cash flow multiple of 25x, no dividends are projected to be paid on shares.
Following a huge rally a month ago, the valuation picture is less appealing than it was after it released Q1 earnings in March. The P/E multiples were in the low to mid-20s at the time. However, add around 30% to those estimates. Furthermore, the EV/EBITDA multiple is 22x the next-12-month adjusted earnings.
As it stands, ADBE’s forward PEG ratio is respectable at 2.0, which is lower than the 5-year average but slightly higher than the sector median. Adobe trades at a forward price-to-sales multiple of 10.7, which is also slightly lower than its long-term average. Given today’s higher interest rates, those figures seem reasonable to me. Overall, the elevated valuation is justified given the firm’s outstanding growth prospects and existing high profitability, but I view the stock as trading near fair value.
Looking ahead, Wall Street Horizon corporate event data shows a definite Q2 2023 earnings date of Thursday, June 15 AMC, with a conference call immediately following the numbers. You may listen in real-time here. There are no major volatility catalysts forecast in the future weeks.
The Alternatives Angle
Data from Option Research & Technology Services (ORATS) reveal a consensus EPS value of $3.79 for the forthcoming earnings announcement. That would represent a 13% rise in operational earnings year over year and a sequential gain from Q1 per-share profits. I anticipate a bottom-line beat because Adobe has outperformed expectations in each of the last 12 reports. However, the share price reaction historically is more ambiguous. The company has moved higher after earnings in the last two reports, while the preceding five have had share price reductions – with a couple around -10%.
When assessing the at-the-money straddle expiring soonest after Thursday’s release, the options market has priced in a 6.5% earnings-related stock price swing. That is the largest premium baked in among the three studies released this year. With relatively calm reactions of 3.3% over the last year, I am likely to sell that premium.
The Technical Point of View
Adobe, like many other tech companies, has been sucked into the AI frenzy. The stock has risen from around $330 in mid-May to nearly $470 at the top last Friday, as shown in the chart below. But I see dangers ahead. What’s telling is that the stock has recovered into the $450 to $520 level for 2020-early 2021. Because that is a high-traffic area, the first try could be difficult. Longs should contemplate harvesting profits with high volume by pricing around where ADBE is now trading.
Furthermore, Adobe stock is overbought in the short term, with the RSI reading at the top of the chart approaching 80. While I like that shares had a strong breakout above a downtrend resistance line around the turn of the month, I believe a retreat is conceivable today. As a result, selling $470 strike calls into earnings could be a good short-term trade. Long-term investors, on the other hand, should try to purchase the dip if the market falls into the low $400s.
I appreciate Adobe’s growth outlook and long-term prospects, but the price seems fair at present, and the technical picture shows a neutral to slightly bearish picture following a solid month of momentum.
Featured Image: Unsplash