Earnings Watch: Will the Adobe money machine continue? Earnings Watch: Will the Adobe money machine continue? Earnings Watch: Will the Adobe money machine continue?

Earnings Watch: Will the Adobe money machine continue?

Equities 8 minutes to read
Peter Garnry

Chief Investment Strategist

Summary:  This week many late Chinese Q4 earnings will be released with the most important ones being Tencent, Xiaomi, and Meituan representing the Chinese digitalisation. We also focus on Adobe which is scheduled to release earnings tomorrow. We take a closer look at concepts such as growth decay, free cash flow generation, and equity valuation theory, and how these concepts under certain assumptions can lead to an outcome matrix on expected return on Adobe shares.


The earnings season is still thin as we are waiting for the Q1 earnings season to kick off in three weeks. But this week we will get a lot of late Chinese Q4 earnings from many major energy, industrial, and banking firms. For emerging markets and the Chinese equity markets overall, the three most important earnings to watch are Tencent, Xiaomi, and Meituan, that represent the Chinese digitalisation. The list below shows all the 30 most important earnings this week.

Monday: China Resources Beer Holdings, Country Garden Services, Tencent Music Entertainment

Tuesday: Wuxi Biologics Cayman, Haidilao International, People’s Insurance Co Group, Geely Automobile, Adobe, IHS Markit

Wednesday:PetroChinaXiaomi, ANTA Sports Products, China Mengniu Dairy, Tencent, General Mills, E.ON

Thursday:China MobileChina Life Insurance, China Evergrande New Energy, Nongfu Spring, CNOOC, Anhui Conch Cement, China CITIC Bank, Country Garden

Friday: China Construction Bank, China Petroleum & Chemical, China Shenhua Energy, Bank of Communications, Longfor Group, Meituan

Adobe: lessons of growth decay and valuation

In this week’s Earnings Watch we will focus on Adobe scheduled to release earnings tomorrow. This is a company that has always been successful and carved out strong niche business delivering software to the creative industry. April 2012 was a transformational year for the company as it released its Adobe Creative Cloud SaaS platform and over time moved more and more customers to the platform. This was the end of on-premise business model and the beginning of a recurring subscription-based business model with more stable revenue and profitability.

The massive increase in predictability of the business is visible in the free cash flow to revenue time series (see chart below. The business model change happened by accident around the same time long-term interest rates began to go down significantly. As we discussed at length with clients this created bond-like valuations of predictable and high-growth assets such as Adobe. The free cash flow yield went from 11% in 2011 to 2% in 2020.

We have long wanted to write about growth decay concepts and equity valuations, and now is a good time and Adobe is a great example. Many variables influence the value of a business but for a high growth company the key is the growth decay, which is how fast and at what level revenue growth will stabilize? The second key variable is what the free cash flow generation profile will be like. For our example and with the knowledge we have today about the industry, Adobe’s market position, and the current trajectory of revenue and free cash flow, the table below shows a likely projection of Adobe’s business until 2028.

YearRevenueFree cash flowFCF / RevenueRevenue growth
201038009430.248
2011421613330.3160.110
2012440412290.2790.044
201340559630.238-0.079
2014414711390.2750.023
2015479612850.2680.156
2016585419960.3410.221
2017730227350.3750.247
2018903037630.4170.237
20191117140270.3610.237
20201286853080.4120.152
20211521063880.4200.182
20221740074820.4300.144
20231978487050.4400.137
20242215899710.4500.120
202524374109680.4500.100
202626324118460.4500.080
202728035126160.4500.065
202829437132460.4500.050

Source: Bloomberg and Saxo Group

In our example we are modeling a gradual decline in the revenue growth stabilizing around 5% in 2028 and the free cash flow generation on revenue increasing from 41% in 2020 to 45% in 2024 and stabilizing. Under these assumptions, revenue will grow to $29.4bn and free cash flow to $13.2bn in 2028. What is a business of this kind worth in 2028 and what does that translate into in terms of expected returns? The free cash flow in 2028 will have to have a discount factor and for equities this is basically the required rate of return, which is the sum of the risk-free rate and an equity risk premium.

On various scenarios for the US 10-year yield and the equity risk premium we get a range of possible annualized returns from the current market value in March 2021. In the one extreme we get a high 30.5% annualized return over until 2028 if our assumptions come true and the US 10-year yield and equity risk premium collapses to 0.5% respectively, and -0.4% annualized if the equity risk premium goes to 3.5% and the US 10-year yield goes to 3%. What is the equity risk premium likely to be in 2028? The historical average for US equities has been around 5% but the nature of Adobe’s business and the predictability of cash flow means that it should be lower. Somewhere between 2-4% is not unreasonable. The example is not to provide an investment recommendation of Adobe but to show how various assumptions and changing their values produces an outcome matrix that can be used for decision making.

 

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article
You can access both of our platforms from a single Saxo account.
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.