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Adobe Is a Top Tech Stock, Recession or Not

By Nicholas Rossolillo – Updated Jun 12, 2020 at 4:16PM

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Adobe offers second-quarter earnings results that support its run higher in recent months.

Despite extreme uncertainty amid the coronavirus crisis and all the ensuing chaos, Adobe (ADBE -1.10%) released stellar results for its fiscal 2020 second quarter (the three months ended May 29, 2020).

Along with rival salesforce.com (CRM -2.02%), which also posted resilient financials during its comparable quarter, Adobe is proving it is in fact an integral part of many organizations' operating needs. Subscriptions to its various creative, advertising, and document management software are holding up just fine and continuing to grow by leaps and bounds, even in economically lean times.

Recession or not, Adobe is a top tech stock that demands attention.

Never mind the recession, digital transformation is here

Entertainment content creation is on hiatus, advertising activity is down, and businesses are looking to tighten up their budgets. Surely Adobe, which relies on all of the above, would be in for some hurt -- right? Wrong. While its trajectory has slowed (in part from the economic downturn, but also because it's already a large enterprise) from the 19% rate in the first quarter of 2020 and 24% in 2019, Adobe's second-quarter revenue during the worst of the market and economic panic notched another big annual gain.

Metric

3 Months Ended May 29, 2020

3 Months Ended May 31, 2019

Change

Revenue

$3.13 billion

$2.74 billion

14%

Gross profit margin

86.7%

85.2%

0.7 pp

Operating expenses

$1.70 billion

$1.59 billion

7%

Adjusted earnings per share

$2.45

$1.83

34%

Free cash flow

$1.09 billion

$1.02 billion

7%

Data source: Adobe. Pp = percentage point.  

Growth in cloud and subscription revenue helped send gross profits (revenue less cost of service) higher once again. And a reduction in new hiring and travel meant operating expenses were far lower as a percentage of revenue than a year ago. Paired with the repurchase of 2.6 million shares during the period, adjusted earnings per share surged 34% higher. Free cash flow (revenue less cash operating and capital expenditures, basically excess cash that gets added to the balance sheet) rose 7% and was good for an enviable free cash profit margin of 35%.  

The economy is far from out of the woods, but the negative effects on this software giant's outlook are limited. Adobe is helping fuel digital transformation for organizations around the globe, and the migration to digital is now more important than ever. Whether it's software for the creation of media, document signing and editing, or marketing management and analytics, Adobe is helping businesses transition to a more modern form of operating as well as implement work-from-home strategies. 

The Adobe Creative Cloud logo, two interlocking circles colored with paint.

Image source: Adobe.

A decelerating, but still rosy, outlook

Much like Salesforce, Adobe said it expects more growth ahead -- albeit slower still as lingering issues related to the pandemic as well as a typically slow summer season weigh it down. Revenue for the third quarter is expected to be $3.15 billion and adjusted earnings per share to be $2.40, year-over-year increases of 11% and 17%, respectively.

Other software firms have reported many new customers hitting pause for the moment as they reassess their situation. That, plus Adobe's size, mean the outlook is plenty good in my book. Shares trade for a premium 45 times trailing 12-month free cash flow; but given the consistent growth, sizable profit margins, ability to make share repurchases (even in times of crisis!), and a cash and short-term investment balance of $4.35 billion, a premium is to be expected.

That's why Adobe will remain a core holding in my portfolio. Some short-term slowdown may lead to concerns later on in 2020, but digital transformation is going to take years to complete. And Adobe is helping lead the charge with its hub for content and marketing management.

Nicholas Rossolillo and his clients own shares of Adobe and Salesforce.com. The Motley Fool owns shares of and recommends Adobe Systems and Salesforce.com. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Adobe Inc. Stock Quote
Adobe Inc.
ADBE
$275.20 (-1.10%) $-3.05
Salesforce, Inc. Stock Quote
Salesforce, Inc.
CRM
$143.84 (-2.02%) $-2.97

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