Adobe: The Early Stage Of GenAI Monetization (Rating Downgrade)

Investment Thesis - Adobe's stock increased over 15% following its Q2 FY2024 earnings, attributed to better-than-expected results despite a depressed market sentiment [2] - The company's revenue outlook is below market consensus and does not indicate a strong growth rebound, with a projected top-line growth of 10.5% YoY in FY2024, which does not justify its premium valuation as an AI-driven growth stock [2][20] - The stock has underperformed the S&P 500 index by nearly 15% since the previous analysis, leading to a downgrade from buy to hold due to unsatisfactory revenue guidance [2] 2Q FY2024 Takeaway - Adobe exceeded both revenue and non-GAAP EPS expectations in Q2 FY2024 but provided conservative revenue guidance, with Q3 FY2024 revenue guidance below market consensus [5] - The company's top-line growth has significantly decelerated since FY2021, remaining flat YoY despite AI initiatives, with a guided 9.5% YoY growth for Q3 FY2024, down from 9.8% YoY in Q3 FY2023 [5][7] - The FY2024 revenue outlook of 10.5% YoY growth aligns closely with the 10.2% growth in FY2023, indicating a lack of growth inflection [5] Revenue Segments - The digital media revenue segment accounted for 74% of total revenue in the last quarter, with a forecasted 10% YoY growth, lower than the 11% YoY growth in Q3 FY2023 [7] - The guided 11.3% YoY growth for FY2024 in this segment is below the 11.5% YoY growth achieved in FY2022, suggesting a lack of upward growth momentum [7] Free Cash Flow (FCF) Generation - Adobe has experienced negative YoY growth in FCF over the past three quarters, with declining FCF margins over the last three years, indicating weak growth in billings [9][10] AI Initiatives and Firefly - Firefly, a key component of Adobe's GenAI portfolio, has generated over 9 billion images in 15 months, showing a nearly 40% growth since Q1 FY2024 [13] - The demand for AI-powered tools is increasing, but the timing of this demand translating into top-line growth remains uncertain [13][16] Remaining Performance Obligations (RPO) - Adobe's total Remaining Performance Obligations (RPO) have accelerated over the past five quarters, indicating potential future revenue, but a robust backlog growth has not yet translated into sequential revenue growth [15][16] Valuation Metrics - Adobe's stock is trading at a premium, with an EV/Sales FY2024E of 10.9x and an EV/Revenue growth ratio of 1.04x, suggesting that the near-term growth outlook does not justify the current valuation [20] - The stock's valuation multiples have decreased from recent highs but remain elevated compared to historical levels [18] Conclusion - Adobe has made progress with its AI initiatives, exceeding revenue and earnings expectations, but revenue growth has not yet picked up, raising concerns about achieving a robust rebound [21] - The FY2024 guidance suggests a flat growth trajectory compared to previous years, and the stock is trading at a premium, reflecting optimistic long-term growth expectations [21]