It's been a great five-year run for creative software specialist Adobe Systems (ADBE 2.44%), with shares sporting a 324% gain in that span. With 2019 coming to a close, the company issued an outlook that was a slowdown from the recent past, but plenty good enough to keep investors happy.
With a new decade nearly upon us, this professional tools suite remains one of the best there is -- albeit at a steep price tag.
Creative software and digital transformation momentum
Adobe has had multiple winds blowing in its favor. Software-as-a-service offerings are in high demand as companies around the globe are updating their operations for the digital age, and Adobe is at the forefront of the movement. First, its Digital Media segment -- which consists of its suite of creative software for artists and graphic designers, the Document Cloud PDF management tool, and its stock photo business -- has continued growing at a better-than-20% rate. Third-quarter 2019 results were 22% higher than a year ago.
The Adobe Creative Cloud. Image source: Adobe.
Then there's Digital Experience, led by Adobe's two big acquisitions in 2018: Marketo (acquired for $4.8 billion) and Magneto ($1.7 billion). The segment helps businesses manage their online marketing and commerce efforts, including advertising, analytics, and content management. The Digital Experience segment notched another strong expansion rate in Q3, growing 34% from the year prior, thanks in large part to those big purchases.
The new business has meant Adobe's gross margin on services rendered is down slightly in 2019, but its strong top-line trajectory more than makes up for that. Besides, the software suite still totes one of the best gross profit margins around.
|
Metric |
Nine Months Ended Aug. 30, 2019 |
Nine Months Ended Aug. 31, 2018 |
Change (Decline) |
|---|---|---|---|
|
Revenue |
$8.18 billion |
$6.57 billion |
25% |
|
Gross profit margin |
85.1% |
87.3% |
(2.2 pp) |
Pp = percentage point. Data source: Adobe.
No outlook has been provided for 2020, but fourth-quarter expectations are for at least another 20% year-over-year increase in the top line. Adobe's remaining performance obligation at the end of Q3 was $8.77 billion -- work or service to be rendered but revenue that hasn't been recognized yet. That compares with $8.47 billion when the company was exiting Q2, offering further proof that this software outfit's momentum is still going strong.
Profits waiting in the wings
Adobe is a huge operation, but it is still spending aggressively to maximize its growth potential. Most notably, last year's acquisitions have elevated operating expenses in 2019, which has kept earnings per share growing at a slower rate than sales.
|
Metric |
Nine Months Ended Aug. 30, 2019 |
Nine Months Ended Aug. 31, 2018 |
Change (Decline) |
|---|---|---|---|
|
Operating expenses |
$4.66 billion |
$3.61 billion |
29% |
|
Operating profit margin |
28.1% |
32.3% |
(4.2 pp) |
|
Earnings per share |
$4.26 |
$3.84 |
11% |
Pp = percentage point. Data source: Adobe.
Even so, Adobe operates a highly profitable business. Free cash flow -- a better measure of the bottom line since it accounts for money remaining after cash operating and capital expenses are paid -- is running at $3.79 billion over the last trailing-12-month stretch.
That cash is being used to invest in the business, but it's also getting returned to shareholders: $750 million worth of stock was repurchased during Q3 alone, and Adobe has another $5.85 billion remaining that it can use for repurchasing shares through 2021. That should help prop up EPS over the next couple of years as Adobe starts to fully reap the benefits of the Marketo and Magneto acquisitions.
Not cheap, but a buy and long-term hold
Given its strong performance and expectation that its current double-digit trajectory will continue, Adobe isn't a cheap stock. It trades for 38.8 times trailing-12-month free cash flow, and 30.6 times one-year forward expected earnings. That's a hefty premium considering the S&P 500 is currently trading for 18.9 times one-year forward earnings -- although earnings growth for the index is pegged at a perhaps overly optimistic high-single-digit figure compared with Adobe's much brighter outlook.
Thus, even at a premium, Adobe is a great buy-and-hold software stock. After a 70% gain since the start of 2018, I'm personally waiting for a pullback before making a purchase. But at the very least, this one deserves to be at the top of growth investors' watch lists.
