Adobe: Fears Have Likely Peaked, Time To Double Down (Rating Upgrade)

Summary:

• Adobe’s fiscal first-quarter performance was robust, but its revenue guidance for FQ2 disappointed Wall Street.
• OpenAI’s Sora AI tool potentially threatens Adobe’s competitive moat.
• Despite the post-earnings plunge, Adobe remains a fundamentally strong company.
• I argue why the pessimism on ADBE could have peaked last week, as the market de-rated it below its long-term average.
• With investors bailing out in droves, it’s time for long-term investors to return and pick up the pieces.

Adobe’s Guidance Disappoints

I provided an update on Adobe Inc. (NASDAQ:ADBE) in June 2023, articulating why I believe the fears attributed to image-generation AI companies were overblown. As a result, I viewed the bullish thesis on ABDE as robust then, arguing why ABDE was poised to break out higher. That thesis panned out accordingly as ABDE surged toward its late January 2024 highs, nearly reaching the $640 level. However, ADBE saw downward volatility in February, worsened by the post-earnings selloff attributed to worse-than-anticipated forward guidance provided at Adobe’s recent earnings release.

Adobe reported its fiscal first-quarter earnings scorecard last week. While FQ1’s performance was robust, questions were asked about Adobe’s ability to monetize AI in the near term, as Adobe’s Q2 guidance was weak across its key revenue segments. Accordingly, Adobe provided a revenue outlook of between $5.25B and $5.3B in FQ2. While the adjusted EPS outlook of between $4.35 and $4.4 aligns with analysts’ estimates, its topline guidance disappointed. Accordingly, Adobe’s midpoint revenue outlook of $5.275B came in markedly below Wall Street’s estimates of $5.31B.

OpenAI’s Sora Threatens Adobe’s Moat?

Furthermore, Adobe management declined to revise its full-year outlook from its previous quarter. Therefore, the creative software company is confident of a more substantial second-half revenue ramp as it looks to monetize its AI offerings better. Despite that, the market was unconvinced since ADBE topped out in January. Moreover, the introduction of OpenAI’s Sora text-to-video AI tool could cause “significant disruption across various industries.” Recall that we dealt with image-generation AI last year, which with fears that it could threaten Adobe’s competitive moat across its creative suite. However, Adobe’s release of its Firefly AI tool has assured investors that the software behemoth has a viable and sustainable plan to outcompete its smaller peers.

Moreover, Adobe management underscored the encouraging adoption of Firefly with enterprise users, “contributing to segment growth.” Hence, while Sora’s challenge seems daunting, I believe the fears over Adobe’s ability to release competitive tools seem overstated. In addition, Adobe highlighted that the company sees the potential for greater collaboration with enterprise partners “to push the boundaries of video editing capabilities.” Adobe also indicated that it believes OpenAI’s Sora has opened up more exciting opportunities for Adobe to pursue, alluding to the move as “a positive driver for Adobe’s video editing tools.”

Questions must still be asked whether such tools could shrink Adobe’s TAM or potentially enhance it. The threat of such highly advanced AI tools could transform or even potentially disrupt current jobs in the creative industry. However, the opportunities for greater productivity could also lead to increased utilization across industries, particularly among smaller companies. Hence, I believe the counter-argument that Adobe remains well-poised to benefit as the creative SaaS leader shouldn’t be discarded at this point. Adobe has demonstrated remarkable prowess in reinventing and innovating over time to stay in front as the de facto leader. While the market is justifiably concerned with the near-term monetization execution, investors should focus on the long-term prize.

Given the steep pullback from its January 2024 highs, ADBE fell almost 25% through this week’s lows, entering a bear market. ADBE also revisited levels last seen in July 2023, as investors fled in droves for the exit. However, ADBE’s valuation has also fallen markedly, as it was last valued at a forward adjusted EBITDA multiple of 20x, below its 10Y average of 24x.

Is ADBE Stock A Buy, Sell, Or Hold?

Adobe is a fundamentally strong stock, and it was assigned an “A+” profitability grade by Seeking Alpha Quant. Given the rapid innovation attributed to generative AI, its dominance in the Creative SaaS market has faced recent challenges.

OpenAI’s Sora seems to have the capacity to threaten Adobe’s moat. It could weaken the stickiness of its tools, given the ability for Sora to work on projects with simpler text prompts. However, Adobe has also demonstrated its ability to launch its Firefly tool, gaining adoption with enterprise users concerned about ensuring they don’t breach commercial licensing regulations. Therefore, I believe Adobe’s ability to keep up with the generative AI players shouldn’t be understated, suggesting the recent selloff seems over-pessimistic.

With ADBE falling back into relatively undervalued zones, I assessed another opportunity for investors to add ABDE more aggressively.

Rating: Upgrade to Strong Buy.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking. Note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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