$ADBE Q3 Earnings Preview

by Enis September 15, 2014 2:43 pm • Commentary

Event:  ADBE reports its fiscal Q3 earnings on Tuesday, Sept 16th after the market close.  The options market is implying about a 5.25% one day move, which is below both the 4 quarter average of about 7.75% and the 8 quarter average of about 6.5%.

Sentiment:  Wall Street analysts are mixed on the stock, with 13 Buys, 8 Holds and 3 Sells, with an average 12 month price target of around $80.  ADBE is already up 18.5% year-to-date, though the stock has been unable to surpass its all-time high of $74.69 set on its June post-earnings gap higher.  ADBE has tripled in the past 3 years, and short interest is only around 1.5% of the float.

Options Open Interest:  Calls and puts have an equal amount of open interest in ADBE, and recent volumes have been surprisingly light for a $35 billion market cap technology company.  The 1 month average volume has also been about evenly split between puts and calls, with an average of only about 1k contracts of calls and 1k contracts of puts over the past month.  The Oct 75 call line is the only one with substantial open interest, at around 8k in total.

Price Action / Technicals:  The $68-$70 area is the critical support area for ADBE.  That happens to be where sellers became more aggressive in February, and then it turned into an area of support after the gap higher in June (marked in red):

[caption id="attachment_45472" align="aligncenter" width="600" class=" "]ADBE daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg ADBE daily chart, 200 day ma in yellow, courtesy of Bloomberg[/caption]

A good portion of ADBE’s gains over the past year have come on gaps higher on earnings.  In that regard, a gap above the $74.69 intraday high from June would be quite bullish in maintaining the momentum for the stock.

As for the longer-term trajectory, ADBE has traded above its rising 200 day moving average for nearly 3 years:

[caption id="attachment_45473" align="aligncenter" width="600" class=" "]ADBE daily chart, 200 day ma in yellow, courtesy of Bloomberg ADBE daily chart, 200 day ma in yellow, courtesy of Bloomberg[/caption]

The 200 day moving average is now around $65.

Fundamentals:  Here is what I wrote in last quarter’s ADBE preview:

ADBE is one of those stocks where valuation has taken a back seat to subscriber growth, as the company transitions to a Software-as-a-Service payment model.

We have long been skeptical of the huge advance in ADBE’s stock price on the basis that the SaaS model will result in a higher level of long-term earnings, especially since the company is not expected to regain its 2011 level of EPS until the start of 2016.  See my Name That Trade post from early May.  Nonetheless, the stock’s persistent advance over the past few years led us to place ADBE in the bucket of stocks where we focus on the technicals rather than the fundamentals, since the fundamentals don’t make sense to us.

We continue to hold that general view for ADBE as a stock.

Analysts have set a low bar for this quarter’s earnings report, with only 2% expected year-over-year sales growth, and an 18% decline in earnings year-over-year, as the “business transition” continues.

Investors will be focused on overall subscriber growth and ARPU (expected in the $33-$35 range), or average revenue per user, as the subscriber base is expected to hit 3.3 million users by year end.

Volatility:  Implied volatility has moved higher into the earnings event as expected, but ADBE’s 30 day implied vol is still at its lowest level in the past year ahead of earnings:

[caption id="attachment_45470" align="aligncenter" width="600" class=" "]ADBE 30 day implied volatility, courtesy of Bloomberg ADBE 30 day implied volatility, courtesy of Bloomberg[/caption]

A major reason why options traders have reduced expectations for volatility in ADBE relative to prior earnings reports is the low level of recent realized volatility in the stock. 10 day realized volatility recently hit a 2 year low:

[caption id="attachment_45471" align="aligncenter" width="600" class=" "]10 day realized volatility in ADBE, courtesy of Bloomberg 10 day realized volatility in ADBE, courtesy of Bloomberg[/caption]

Our View:  We don’t view the fundamental or technical setup as bullish in ADBE, but the stock has risen on 7 of the last 8 earnings reports, so we don’t plan a directional trade into the event.  We might look at a nuanced options structure that takes advantage of high front month volatility, as the technical situation does look rangebound between $65 and $75.  The risk of a big move has generally been to the upside rather than the downside in ADBE, so we might wait until after the event to initiate a new trade.  Stay tuned.