My 'first look' at Adobe; A wonderful love story from Ukraine
1) Last week, my readers overwhelmingly voted for me to take a closer look at software maker Adobe (ADBE)...
The company is best known for its ubiquitous Creative Cloud suite of programs. And as I noted in Thursday's e-mail, the stock has been an extraordinary performer over the past two decades... but it took a beating in 2022 and has traded mostly sideways for the past four years, as you can see in this chart:
As always, before I listen to the inevitable bull case spun by management and/or Wall Street "analysts," my first step is to look at a company's financials – starting with two decades of revenues and profits.
As you can see in the chart below, while Adobe's revenues have continued to grow, profits have stalled in recent years – meaning margins have declined:
Sure enough, we can see that Adobe's net margin has declined from a peak in 2020 (though the company has maintained a significantly high gross margin of nearly 90% for the past two decades):
Note that the fabulous increase in net income margin from 2014 through 2020 was largely driven by a smart shift in 2013 from selling perpetual software licenses to a subscription-based model (Creative Cloud).
The big spike in profits and net margin in 2020 looked weird to me, so I looked into it. Sure enough, COVID-related legislation enabled Adobe to claim a huge tax refund in 2020... which flowed through to the income statement.
If we instead look at operating income and margin by quarter since 2017, we can see that margins have actually been stable over the past four years, and hence operating income has risen in line with revenue growth:
Turning to the cash-flow statement...
As you would expect for a software business, Adobe is extremely capital-light – meaning almost no capital expenditures ("capex"). However, its trailing-12-month ("TTM") operating cash flow has declined by 14% over the past year and a half – and that means free cash flow ("FCF") has also dipped. Take a look:
As for the balance sheet, except for a single year in 2018, Adobe has always maintained a healthy net cash position:
So what has Adobe done with all of its FCF?
The company has bought back increasing amounts of stock and made many acquisitions (the four largest of which were in two fiscal years: Magento and Marketo in 2018 and Workfront and Frame.io in 2021):
In the past 10 and a half years, Adobe has spent $40 billion buying back stock – equal to about 17.3% of its current market cap – but its diluted share count is only down 11.6%:
Why hasn't the share count declined further? That's because, like most tech companies, Adobe gives its employees boatloads of stock options.
To summarize what Adobe's financials are telling us, this is an incredible company with mouth-watering economic characteristics: predictable, growing revenues, sky-high margins, huge cash flows, and minimal capex.
But the stock is trading at nosebleed valuations and artificial intelligence could be a threat, so I'll take a deeper look tomorrow... Stay tuned!
2) As you read this, I'm on a flight home from Warsaw, having spent the past 11 days in Ukraine...
As you know, the war there has become hyper-politicized in the U.S. – and I keep my personal politics out of my daily e-mails – so I won't discuss the details of my trip here.
However, I'll briefly mention that a few days ago in Kyiv, two of my friends and I were walking back from lunch and asked a young couple passing by if they would take our picture. We got to talking and they have a wonderful story...
Andrii is a soldier who lost his lower leg a year ago to a mine blast. He was in New York City getting treatment via an organization called Kind Deeds when he met Olga, an architectural designer from Poland who was working in the city and volunteering at Kind Deeds.
Though they didn't speak a word of a common language, they fell in love, she moved to Kyiv with him when he completed his treatment, and they're getting married next month! Here's a picture of all of us:
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.