Ratings: Digital Imaging Looks Sharp

With a solid first quarter and exciting new products, Adobe is still one of our favorites to own.
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Earlier this year we selected


(ADBE) - Get Report

as one of seven companies to own for 2007.

Like a lot of other software stocks, Adobe initially drifted downward, but it has gained back 9.2% since the beginning of the month on investor anticipation of upcoming events.

On March 20, the company reported slightly better-than-expected results. Net income was up 33% to $143.8 million, or 24 cents per share, compared with the same quarter last year.

Solid Adobe

More importantly, management claimed the franchise was solid despite customers holding off on orders until the release of Creative Suite CS3 next week.

The company reaffirmed a bullish outlook for 2007, with 15% annual revenue growth potential and slightly better operating margins of 25% to 27% for the year.

The new CS3 graphics software would be the first release in two years. This may also signal that the Macromedia acquisition is starting to bear fruit.

With this product introduction and financial community presentations next week, expect to hear a lot of buzz in the press about Adobe products.

But the full earning power of this company may not materialize for another six months. Management clearly cautioned investors to expect the bulk of product shipments to be late in the second quarter, with the third quarter seeing substantially higher revenue.

To watch Aaron Task interview Rudy Martin about digital-imaging stocks on TV, click here.

The company also implied that this order lag may be an additional drag on seasonably weaker second-quarter results. Lost in all this excitement about new products is that net cash from operations is running at an annualized rate of almost $1 billion per year.

This, along with $2.3 billion in cash and short-term investments on the balance sheet and no major long term debt, indicates that the company has more than ample resources for future acquisitions or even more aggressive share repurchases.

With digital imaging going mainstream, we are looking forward to hearing in the coming weeks how management intends to put its capital to work to take advantage of this boom.

Rising Tide

The Interactive Advertising Bureau and PricewaterhouseCoopers estimated that Internet advertising revenue for 2006 was a record $16.8 billion, a 34% increase over the previous year.

As the leading vendor of imaging tools for professional developers, Adobe stands to be a major beneficiary of this growing use of digital images on the Web.

Below are some facts from the market research firm Parks & Associates that point to a robust future for digital imaging companies:

  • 84% of Americans have digital photos but no cameras (get them emailed).
  • The average U.S. consumer has 1,200 digital photos.
  • Consumers collect content, but only one-third share it.
  • The U.S. is falling behind other countries in offering TV via the computers.
  • More TV tuner products will be launched.
  • Fewer TV programs will be watched exclusively via a TV set.
  • Microsoft's new Windows Vista Media Center allows for TV viewing but does not supply a TV tuner.
  • 25% of the U.S. now has HDTV.

Canon Fodder

The clearest beneficiary of digital imaging trends, however, is


(CAJ) - Get Report

. The company has a very large portfolio of global products, including the Canon high-definition video camcorders (HV10 and HV20) that offer stunning image quality at reasonable prices. There is also a professional series at much higher price points.

In addition to the consumer aspects of digital, Canon also serves the business market. It manufactures copy machines and computer peripherals, mainly laser and bubble-jet printers, business systems (such as faxes, computers, micrographics and calculators), single-lens reflex cameras, compact cameras, digital cameras and video camcorders.

Fundamentally, our stock ratings model gives Canon high marks across the board. The following chart shows that the market seems to agree.

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Waning Enthusiasm for Avid

But not all stocks are as well positioned for the digital revolution as Adobe and Canon.

For example,


(AVID) - Get Report

, a $1.3 billion market-cap company that creates digital media production, management and distribution software, is on the more speculative potential takeover side.

Avid management has made it clear that it is recovering from a series of very poor product introductions and has had to take extra effort to restore customer service levels.

Initially, the company was known for its specialization in post-production editing of film for professionals. But now it also offers a range of video and music creation software for individuals too.

To this point, Avid has expanded its product offerings through acquisitions, but over the last three quarters, top-line revenue grwoth has slowed and turned negative. Fourth-quarter 2006 revenue of $239.05 million is 2.4% lower than in the same quarter the previous year.

Proactively, management has sold off some low margin manufacturing operations and outsourced many engineering functions.

The risks are clear. The company faces competition from lower-cost Asian producers that offer basic tuners without the higher value added features of Avid.

While the company has no long-term debt outstanding and $172 million in cash as of the fourth quarter of 2006, Avid management is not expecting 2007 results to illustrate a full recovery from 2006. Our stock model rates Avid a weak hold.

But there are indications that Avid's fortunes could turn around.

On March 6, the company announced that its consumer division, Pinnacle Systems, is entering the market for Mac computer peripherals with three new USB TV tuner devices. One is designed for the U.S. and two for Europe.

Now, any Mac can be used to watch or record television with the new ultra-portable Pinnacle TV for Mac Sticks.

Ideally you could set up a wireless connection on your computer that hooks up to your media center. This technology could become a standard part of home entertainment systems in living rooms around the world.

If the company isn't acquired first, Avid is on the short list for consideration for stocks to watch for 2008.

Rudy Martin is the director of research for Ratings. In keeping with TSC's Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

In keeping with TSC's Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

While Martin cannot provide investment advice or recommendations, he appreciates your feedback;

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