Event: Adobe (ADBE) reports their fiscal Q2 results tonight after the close. The options market is implying about a 5% one day move tomorrow, which is rich to the 4 qtr average one day post earnings move of 2.6%. Following their Q1 results on March 17th the stock gapped up nearly 9%, only to close up 3.85% very near the lows of the session:[caption id="attachment_64510" align="aligncenter" width="600"] From Bloomberg[/caption]
Price Action / Technicals: ADBE is up 5% on the year, and just 2% from its 52 week and all time high made late last month. The stock has a tad bit of technical support at $95, and then not much till $90, which was the gap level from mid March. On the upside, the prior high of $100.6o is all that you have for resistance and if it is going there I suspect it is breaking right through:[caption id="attachment_64511" align="aligncenter" width="600"] from Bloomberg[/caption]
Taking a longer term view, a break of the uptrend that has been in place since late 2012 could yield a re-test of the Aug 2015 / Feb 2016 double bottom low near $70:[caption id="attachment_64512" align="aligncenter" width="600"] from Bloomberg[/caption]
Sentiment: Wall Street analysts are fairly bullish on the stock with 18 Buy ratings, 7 Holds and No sells with an average 12 month target of about $111, about 12% higher than current levels. Short interest at less than 1% of the float.
Valuation: there is a fairly large gap, between a P/E on an Adjusted basis vs a GAAP earnings. On an adjusted earnings basis, EPS is expected to grow 36% to $2.84 in 2016, which places ADBE’s P/E at about 35, or 1x expected growth. On a GAAP basis, earnings are expected to grow 64% to $2.03, higher growth off of a lower base, but considerably lower on the E side, ADBE shares trade at 49x, a tad more egregious.
Why is this comparison important? Last June Barron’s got to the heart of the issue in an article titled How Much Do Silicon Valley Firms Really Earn?, emphasis mine:
“A company that pays employees entirely from its income statement is more attractive than a company that needs to issue and repurchase millions of shares per year for its employees.” Adobe, for instance, trumpets its buybacks, calling them a return of cash to shareholders. However, its equity issuance to employees has exceeded its buybacks in the past three years, resulting in a higher share count over that span.
So any way you slice it, valuation is a moving target. Relative to expected growth it is fair. But on a GAAP basis it could stick out like a sort thumb if growth were to moderate.
My View: When the company reported in March, they stated they will no longer give Creative Cloud subscriber numbers as they would like analysts and investors to focus on annual recurring revenue (ARR) which should better demonstrate the longer term benefits of the transition towards cloud offerings, as opposed to short term subscribers gains/adds.
A meaningful miss and guide down and the stock is down at least in line with the 5% implied move, but likely down 10% by the end of the week towards $90.
A beat and raise and the stock is clearly in uncharted territory. But I suspect a run-away breakout is unlikely given valuation and the potential that the stock sees profit taking similar to last quarter.
So what’s the trade?
ADBE only has monthly options for those looking to define their risk into the print, which for lack of a better term, limits options when it comes to trading in the name.
If you were inclined to play for a breakout, but hesitant to buy so close to the highs, you might consider a risk reversal. For instance with the stock at $99.20 you could sell the July 92.50 put at $1.05 and buy the July 100 / 105 call spread for $1.85. This call spread risk reversal would result in a net debit of 80 cents, offering a break-even at $100.80, with gains up to 4.15 up to 105, with max gain above. Below 100 lose the 80 cents, and worst case scenario put stock down at $92.50.
While that’s not great, and the short put does not exactly define ones risk, I prefer that to long stock here for those playing for a breakout.
Estimates and Forecasts from Bloomberg:
-2Q adj EPS est. 68c (range 66c-72c); co. forecast 64c-70c (March 17)
-2Q rev. est. $1.40b (range $1.39b-$1.43b), co. forecast $1.37b-$1.42b (March 17)
-2Q Creative ARR $3.0b (average of two estimates compiled by Bloomberg News)
-FY16 adj EPS est. $2.84 (range $2.80-$2.97); co. forecast $2.80 (March 17)
-FY16 rev. est. $5.83b (range $5.80b-$5.96b), co. forecast $5.8b (March 17)