Adobe (ADBE) - Get Report was one of the first large companies to report in detail on the implications of the coronavirus outbreak for its underlying business. And the message was overall highly reassuring, in that while there is going to be some near-term impact plus a lot of uncertainty, overall the company will continue to grow its operations.
In fact, given the roughly 25% drop in its market cap these past few weeks, today Adobe's valuation presents investors with a very rare investment opportunity. Here’s why:
A Very Welcome Message
Adobe’s CEO Shantanu Narayen addressed analysts and investors’ concern head-on. Given the very fluid situation with coronavirus outbreaks globally, Adobe could have easily pulled its Q2 2020 guidance.
But not only did it not pull its guidance, it actually pressed ahead and guided investors for Q2 2020 revenues to increase 16% to $3.2 billion.
Furthermore, Narayen noted on the call that right now more than ever before "if you can’t engage with your customers digitally, you are dead in the water."
Having said that, Narayen acknowledged that Adobe was seeing customers defer bookings, delay consulting spending and reduce marketing spend, which would all weigh on its near-term revenue growth rates. Also, Adobe is cutting back on some of its operations, such as the Adobe Summit in Las Vegas, as well as cancelling in-person corporate events. This would add some minor one-off expenses to its bottom line in Q2 2020.
Consequently, while there is no doubt that Adobe’s operations are going to be suboptimal in the near-term, Narayen contended that Adobe will come out of this unprecedented situation stronger.
Balance Sheets Truly Matter Right Now
Adobe ended Q1 2020 with $4 billion of cash and equivalents. While it does have some debt on its balance sheet, it’s not due over the coming 12 months.
Given that the markets have been in free fall, there are good reasons to believe, albeit not with any certainty, that strong cash flow generating companies, such as Adobe, will use this opportunity to acquire smaller strategic peers at bargain prices.
Further, Narayen noted that he was bullish about Adobe’s prospects given that its revenues are largely subscription-based, lending its operations towards stable and predictable growth prospects.
Valuation – Large Margin of Safety
With the markets in full panic mode, the requirement that investors be highly selective has never been more important. Innovative companies with stable operations and strong cash flows will make for rewarding opportunities for investors with the stomachs to hold them over the next two years.
Indeed, Adobe has been growing its annual revenues at 18-20% for a considerable number of years, while at the same time it has very high GAAP operating margins of close to 30%.
Given its regular share repurchase program, Adobe's bottom line EPS has actually been growing far faster than its revenue growth rate, with its EPS growing at a three-year compounded annual growth rate of mid 30 percent.
Paying 30x trailing cash flows for a business with GAAP EPS compounded annual growth rates in the mid-30s percent is a terrific opportunity.
What’s more, Adobe notes that it still has roughly $4 billion to deploy towards repurchases, set to expire by the end of 2021. Given the recent sell-off, patient investors should be nicely rewarded at this valuation.
The Bottom Line
Adobe is a well established business that finds itself at the center of three massive market opportunities across creativity, digital documents and customer experience management.
Given its strong and predictable cash flows, together with its low valuation, this high quality business is a highly worthwhile opportunity to consider.