Dollar Stumbles Awaiting U.S. Jobs Report

The US dollar fell against all major pairs on Thursday. The greenback had touched 16-month highs on Wednesday but could not hold on to those gains amid positive Brexit news and solid trade data in Australia, combined with investors taking profit in their long dollar positions. The release of the U.S. non farm payrolls (NFP) report on Friday, November 2, at 8:30 A.M. EDT could turn the tide for the dollar, but investors looking beyond this week will take into consideration political risk as the US midterms take place on Tuesday, November 6.

The US dollar lost its appeal as a safe haven as President Donald Trump tweeted about having a good talk with Chinese leader Xi Jinping. The two will meet in Buenos Aires ahead of the G20 summit, with trade a big topic under discussion.

  • US forecasted to have added 200,000 jobs in October
  • US earnings to remain upward trend at 0.2 percent gain
  • Canadian jobs to show 12,000 gains in October

Dollar on Back Foot Ahead of Jobs Report

The EUR/USD rose 0.90 percent on Thursday. The single currency is trading at 1.1412 after the US dollar hit a brick wall after on its way to a 17-month high. The scenario of a US economy overperforming in trade war risk aversion gave strength to the dollar, but the script has changed with the US dollar on the back foot as the major upcoming risk event are the US midterms, with investors limiting their dollar exposure while positive indicators have appeared abroad.

The euro rebounded against the greenback with an eye on the US jobs report on Friday. Employment has been a strong pillar of growth and supported the view of the Fed to keep tightening monetary policy. The upcoming October data will not change that, but it will have to be exceptional to change the view of the market on perceived political risk out of Washington.

Europe is no stranger to political risk as it battles on two fronts. The Italian budget dilemma continues after the European Union rejected the proposal of a member for the first time and gave Italy three weeks to make a list of changes. Italian politicians are digging their heels as Brussels and Rome head for tough negotiations.

Sterling Surges on Brexit Hope and Dollar Softness

The GBP/USD gained 1.96 percent. The currency pair is trading at 1.30 after reports of a financial services agreement between the EU and the UK made the rounds. Officials from both sides denied there being an actual agreement, although the matter, as anything Brexit-related, has been discussed for months. While it was deemed as speculation, the fact remains that it was also not denied which was good enough for the market pricing in further pound strength.

The various comments, both official and unofficial, point to a deal being close. As always with Brexit rhetoric, there have been few details disclosed. There is optimism on both sides, although the team in Brussels is more cautious.

As part of its “Super Thursday,” the Bank of England (BoE) Governor Mark Carney had a neutral rhetoric about the Brexit outcome, saying the central bank is ready to do what it must in either outcome. He did comment that the hard exit is an unlikely scenario and is confident about the levels of preparations done by the financial services industry ahead of the imminent divorce.

Gold Retakes Safe Haven Crown from Dollar

Gold rose 1.64 percent on Thursday after trade fears eased, sapping the attraction of the US dollar as a safe haven. The upcoming US midterms are the next major risk event and investors are limiting their exposures to the US currency.

The US economy has been a solid performer this year and the U.S. Federal Reserve has moved towards rate normalization with three rate hikes in 2018. Another rate hike is expected at the December Federal Open Market Committee (FOMC) meeting, if economic indicators remain strong.

Gold has reclaimed a seat at the safe haven table after a difficult start of the year. Demand for the metal has risen from retail investors and central banks keeping prices above $1,230.

**Oil Free falls on Oversupply Fears **

Oil prices tumbled on Thursday as the market is anxious about oversupply ahead of the start of Iran sanctions. Organization of the Petroleum Exporting Countries (OPEC) and other major producers appear to have gotten the message from US President Donald Trump and increased production, but there are still questions on how much will the sanctions actually impact Iranian exports.

West Texas Intermediate graph

Iran’s biggest customers have bowed down to US pressure and might still work out exemptions or try to exploit loopholes to keep purchasing crude from its long time supplier.

There are reports that India was able to get US sanctions waivers in exchange from reducing its Iranian imports by 35 percent.

Market events to watch this week:

Friday, November 2

8:30 A.M. CAD Employment Change
8:30 A.M. CAD Trade Balance
8:30 A.M. CAD Unemployment Rate
8:30 A.M. USD Average Hourly Earnings m/m
8:30 A.M. USD Non-Farm Employment Change
8:30 A.M. USD Unemployment Rate

*All times EDT

Adobe: Expanding Net Margins And Digital Media Products Are Driving Growth

Introduction

Adobe Systems Inc. (NASDAQ:ADBE) has produced some amazing financial results during the last 3 years (2015 to 2017). 2018 is looking to be a record year for the company. Even if the stock is currently selling at a Price-Earnings ratio above 50, I think the company is still a good investment for growth investors.

The company’s strategy to focus on selling its products via its Cloud/Subscription plans has improved the net margins dramatically. This trend should continue as sales from its product subscription plans now make up more than 80% of its total revenues.

Financial Results

Source: Adobe Annual Report 2017

As we can see in the Income Statements table, revenues have increased at a growth rate of 15.8% per year between 2013 and 2017. Even better, revenues grew by 23% between 2015 and 2017. If we look at ADBE’s quarterly results for 2018, we can estimate revenues to reach $8.7-8.8 B by the end of 2018, which would represent a 1-year growth of 20%.

What I like the most about ADBE’s financial performance is the improvement in net margins. Profit margins improved from 7.2% in 2013 to 23.2% in 2017. If we look at the company’s quarterly results for 2018, we can expect the net margin to be around 27-30%. This is quite an improvement from 2013.

The main driver behind the improvement in the company’s net margins is certainly the shift of its revenues from selling Products to selling Subscriptions. Let’s have a look at the 3 tables below:

Source: Adobe Annual Report 2017

As we can see, and as we will discuss in the ‘Discussion and Outlook’ section, the company is now generating a very large percentage of its revenues from its Cloud subscription plans. We will also discuss how the company has categorized its products into 3 reportable segments: Digital Media, Digital Marketing, and Print & Publishing.

A quick look at the balance sheet shows that the company is in a good position to cover its short-term liabilities, with a current ratio above 2. Liabilities are growing at a faster pace than assets, as ADBE made a few acquisitions during the last 5 years. The company also bought Magento and Marketo in 2018. Investors should keep an eye on this aspect of the business as we move forward.

Stockholders’ equity grew at a modest rate of 5.9%. I like to see equity grow at a faster rate. However, the company completed some acquisitions and repurchased some of its shares. At this time, I am not too concerned about the growth in liabilities and the modest growth in shareholders equity.

Valuation

DCF Model

The output of my DCF model provides a price per share of 251$ / share. At its current price of 248,15$ / share, the shares seem to be selling at a fair value. The price target for the next year (12 months) is 280$ / share. This is 12% above its current market price.

P/E & PEG Ratios

Let’s now look at ADBE’s P/E and PEG ratios against some of its peers:

Company Name Growth (5 yrs) P/E PEG
ADBE 32.6% 52.36 1.6
Peers
MSFT 13.1% 49.43 3.7
CLGX 10% 20.57 2.1
ORCL 8.16% 50.32 6.2
Average 15.9% 43.17 3.4

Given the numbers in the table above, I conclude that ADBE is selling at a decent Price-Earnings given its expected growth potential.

Discussion and Outlook

With revenues growing at +20% and net margins now approaching 30%, the company has done quite well during the last 3 years to generate positive cash flows for its shareholders. Here are 2 quotes from the company’s Q4 FY2018 targets:

Digital Media segment revenue ~22% year-over-year growth

Digital Experience segment revenue ~20% year-over-year growth

The question here is whether the trend is sustainable or not. I will discuss the company’s growth potential during the next 5 years.

Increasing Revenues from Subscription plans

The main driver behind the improvement in net margins is that the company now makes most of its sales from monthly or annual subscriptions. Users now download the products and pay a monthly/annual fee to use them. The company does not have to print CDs, package them and sell them through stores anymore. Purchasing is now made on the net directly to ADBE. Most software companies are now using this strategy to sell their products. Costs to produce the CDs are now a thing of the past, and the profits do not have to be split between developers and store operators.

As we have seen in the Financial Results section, ADBE’s percentage of sales produced from its Subscription plans has increased year after year and now makes up 84% of its revenues (2017). I expect this trend to continue and reach +90% within the next 5 years.

Revenues from all 3 of the company’s segments are shifting to subscription plans.

Digital Media Segment

In ADBE’s financial statements, the company recognizes its revenues from 3 distinct segments: Digital Media, Digital Marketing, and Print & Publishing.

The Digital Media Segment is the most lucrative of the segment, and the one growing at a faster rate. The products listed under this segment include Adobe Photoshop & Lightroom, Adobe Illustrator, Adobe InDesign, to name a few.

These products are used by professionals working in graphic design, photographs, web developers, animators, designers, etc. Even if the competition is stiff, most notably from Apple (NASDAQ:AAPL), Autodesk (NASDAQ:ADSK), Corel, and Microsoft, the branding of ADBE’s products is solid and we should expect these products to be in high demand by graphic design professionals in years to come.

ADBE also offers various plans to its users. Its clients can choose the plan that suits them so they can use the products they need to support their work. The Digital Media Segment Subscription Plans are supported by Adobe Creative Cloud.

The Digital Media Segment makes up 68.5% (2017) of ADBE’s revenues. With an average growth rate of 27% between 2015 and 2017, I expect this segment alone to provide 10-12% growth during the next 5 years.

Digital Marketing Segment

The Digital Marketing Segment is the second-largest segment of the company. The products from this segment are offered through Adobe Experience Cloud. The products offered through the Experience Cloud includes Adobe Analytics, Adobe Audience Manager, Adobe Experience Manager, Adobe Media Optimizer Search, etc.

These products enable customers to develop their web marketing strategies and help them deliver their products to their targeted audience.

This segment represents 30% of ADBE’s Revenues (2017) and it is growing at a rate of 18.5% since 2015. The competition is, however, quite stiff, most notably from Google (NASDAQ:GOOG) (NASDAQ:GOOGL). The company should be able to grow its revenues from this segment because of the growth potential from the Web Marketing/Advertising market. However, because of the presence of Google, I would expect the growth rate to slow down in the following years. A growth rate of 10-12% from this segment would provide 3-4% growth in ADBE’s top line during the next 5 years.

ADBE’s latest acquisitions (Magento, Marketo) should boost the offering from this segment. It remains to be seen what will be the impact of both acquisitions on the profitability and growth of the Digital Marketing Segment.

Print & Publishing Segment

The Print & Publishing Segment of ADBE generates the smallest percentage of the company’s revenues. The star product offered under this segment is Adobe Acrobat. This is one of the better-known products offered by ADBE.

This segment only accounts for 2% of ADBE revenues (2017). Revenues from this segment have been declining since 2015 at a rate of -5.4%.

At this point, I do not think that the Print & Publishing Segment will have a large impact on the company’s growth during the next 5 years.

Recurring Revenues

We have noted above that the Subscription plans have a positive impact on the company’s net margins. We must also acknowledge that subscriptions have another non-negligible advantage: Recurring revenues.

Monthly and annual fees cost less to customers upfront, but after 2-3 years, the company will generate more cash flow than collecting cash by simply selling its products once. Monthly and annual fees are also easier to predict, which will reduce some of the risk when analyzing the company’s financial results and predicting future income.

Information on its Q3 FY2018 Earnings Call seems to back up my expectations:

And approximately 90% of our revenue in Q3 was from recurring sources.

International Sales

ADBE generates its revenue across the globe. However, as we can see in the table below, sales from the United States represent above 50% of the company’s business.

Revenue (in Millions USD)

2015

2016

2017

% Growth

Americas:

USA

2,548

3,087

3,830

22%

Others

240

312

386

26.8%

Total Americas

2,788

3,400

4,216

23%

EMEA

1,336

1,619

1,985

21.8%

APAC

Japan

348

401

524

22.7%

Others

323

434

576

33.5%

Total APAC

671

835

1,100

28%

Total

4,796

5,854

7,301

23.3%

Values in Million USD

Source: Adobe Annual Report 2017

Even if the American market will still provide most of the growth during the next 5 years, I see a real opportunity for the company to gain market shares in Europe and in the Asia-Pacific area during the next 10 years. This could be a major growth driver for long-term investors.

To increase its sales in Europe, Management provided this information on its Q3 FY2018 Earnings Call Script:

We transitioned our Adobe.com sites in Europe to comply with new GDPR requirements, and we are successfully engaging with potential and existing customers – allowing us to continue to drive growth in revenue and ARR.

Risks

The company has its share of risk that could undermine the profitability of its operations in years to come.

Here is a list of risks investors should carefully monitor:

  • Stiff competition from heavyweights such as Microsoft, Google, Apple.
  • Currency fluctuation: The company reports its revenue in USD; however, it transacts around the globe in various currencies.
  • Interest rate: The company’s liabilities are manageable; however, a rise in the interest rate could have an impact on future cash flows.
  • Market risk: The company currently has a valuation above market average. Given the volatility of the market, growth stocks such as ADBE could undergo larger fluctuation than other stocks.

Conclusion

Adobe has the tools to provide growth rate of 12-15% in years to come, because of the following aspects of its business:

  • Solid products, most notably from its Creative Cloud offering, that are leaders in their market.
  • Expanding net margins from the shift of its sales to its subscription plans offering.
  • Recurring revenue from its subscription plans.
  • Expanding market in digital media, web development, graphic design, animation, etc.
  • Gaining market shares outside of the United States, most notably in Europe and in the Asia-Pacific region.

Even if the stock is currently trading at a price-earnings ratio above 50, its current momentum, expanding net margins and growth potential make ADBE a solid investment at its current market price.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ADBE over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.