ADBE/Adobe: Will The Strong Growth Continue?

Strong Q1 2021 earnings

On March 23, 2021, ADBE announced strong Q1 results and raised its annual targets.  Year-over-year (yoy) results for the quarter were solid: revenue grew 26% and diluted non-GAAP EPS was up 38%.  Segment growth was equally impressive: Digital Media was up 32% yoy, Digital Experience up 24%, while remaining performance obligation grew 17%.  Performance was impressive even after adjusting the numbers down by ~8% to reflect the fact that this quarter benefited from an extra week due the company's 52/53-week financial calendar.

This strong performance continues the string of consistently strong revenue growth, margin expansion due to operating leverage, and earnings growth over the last 5 years.  

Stock price did not respond immediately to the strong earnings

Counter-intuitively, the stock price, which had fallen as much as 20% from its 52-week high of $536, pulled back below $450 after the announcement before trending up.  

At a free cash flow yield of 2.2% prior to the earnings announcement, the valuation is not cheap, but potentially justifiable by the strong earnings growth, particularly in today's low interest rate environment.  

Will the strong growth continue?

On the earnings call, analysts questioned the total addressable market size (TAM) and sustainability of the growth rate of the company, which I thought management responded well to.

From the data, every one of the geographies (indexed to 2018) has grown at attractive rates.

      (source: company SEC filings)

Gross profit for Digital Media, by far the largest segment and most important driver of ADBE's revenue and gross profit, has also continued its strong growth; Digital Experience, which is still going through a "turnaround", has decelerated but will hopefully resume a growth trajectory under the new general manager Anil Charkravarthy, who was previously CEO of Informatica and well-qualified to lead the effort.  (Publishing has been flat, but is too small to move the needle in either direction)

      (source: company SEC filings)

Web employment should be an important driver of future growth

As internet/web employment rises and a greater component of omni-channel marketing campaigns move online, it is inevitable that two things will happen, both of these will drive the demand for ADBE's Digital Media and Experience products.

(1) the quality and aesthetics of the websites must increase, and 

(2) the number of licensed seats will grow

According to the December 2020 report by the

US Bureau of Labor Statistics (BLS), the number of internet publishing and web search portal jobs have increased by over 90,000 since 2016 (red line), and represents over 50% of all publishing jobs (up from 36% in Q1 2016).  Conversely, publishing jobs in the news, periodical, and book businesses have shrunk.

The year-over-year growth in internet/web employment has been around 10% for the last 3 years (red line).

Even though the data provided by the BLS ends in Q2 2020, the evidence that more of the world has shifted online due to the COVID pandemic is compelling and can be expected to continue driving internet/web employment.  As such, it may be a good assumption that demand for ADBE's Digital Media and Digital Experience products will continue to grow.

Indeed, the year-over-year revenue growth in 2020 have not skipped a beat.

Will the growth rate decelerate when workers start returning to the office?

We can debate whether companies were spending money saved from travel  on software licenses and if employees will be asked to share ADBE accounts after they return to the office (the answer for the latter is likely to be "no" if employees work from home even part of the time).  However, I think it is a good bet that there is a long way to go before the world comes even close to full internet penetration.  

As long as companies strive to increase their presence and out-do each other in cyberspace, ADBE's picks and shovels, which a generation of web professionals have been trained on, should continue to grow in demand.  Competitors like Corel and Affinity may pick up share around the edges but ADBE will be the main beneficiary.