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No Weakness in ADP, Paychex

Posted on Tuesday, Feb 26th 2008

We have been looking at various Human Resources related services businesses recently, especially with a multi-part interview series with Michael Gregoire, CEO of Taleo (Nasdaq: TLEO). Taleo has not signaled any weakness due to the economy. One would expect the payroll providers to signal weakness. Let’s take a look at their numbers.

Automatic Data Processing, Inc. (NYSE:ADP) released its Q2 earnings on February 1. Earlier coverage is available here. It reported revenue of $2.15 billion, up 15% y-o-y and 7.5% q-o-q with over 12% growth on a constant foreign currency basis. Diluted EPS grew 22% to $0.55 from $0.45 a year ago on fewer shares outstanding. Fiscal year to date, ADP bought back over 18 million shares of its stock for nearly $842 million.

Segment-wise, Employer Services showed 11% growth in revenue, with 10% organic growth and 8% growth in the US payroll and tax filing business. Beyond Payroll, revenues grew 16% in the U.S. Professional Employer Organization (PEO), ADP’s HR software business saw a revenue growth of 22%. Dealer Services had a revenue growth of 9.5%, with 7% organic growth.

Despite the broader market weakness, ADP expects a strong 2008. It plans to expand its sales force by 5% to 6%. It expects revenue growth of 12% to 13% for 2008. Its stock is trading around $41 after hitting a 52-week low of $37.74 on February 7. Market cap is around $21.5 billion.

Chart for Automatic Data Processing, Inc. (ADP)

On December 19, Paychex, Inc. (NASDAQ:PAYX) reported its Q2 results. Earlier coverage is available here. Net income was $147.1 million up 11% y-o-y. Diluted EPS was $0.40, up 14% y-o-y. Total revenue was $507.8 million, up 12% y-o-y. It completed its $1 billion stock repurchase program (announced in July) on December 14, 2007, for 23.7 million shares of common stock. It paid $226 million in dividends in the first six months and $865 million in stock repurchases. Return on equity for the past twelve months was 30%.

Segment-wise, Payroll Service revenue grew 9% y-o-y to $361.6 million with growth led by client base growth, higher check volume, and price increases. Human Resource Services revenue was $115.5 million, up 24% y-o-y.

For fiscal 2008, Paychex expects payroll revenue growth of 8% to 9%. To help its Major Market Sales (MMS), it has a new time/labor management offering called Time in a Box. It has also partnered with Taleo for applicant tracking. Its stock is trading around $33 after hitting a 52-week low of $31.40 on February 7. Market cap is around $12 billion.

Chart for Paychex Inc. (PAYX)

So, both major payroll providers are trading close to their 52-week lows, but neither are signaling any weakness. Investors have beaten them down by speculating layoffs due to a weakening economy. Perhaps, this is the time to Buy these stocks for the long-term.

Also, the intriguing question is this: how come they are not signaling weakness? The job boards are! The answer may be that there is still a large untapped market that does not use payroll services, and these companies are simply growing by selling into those accounts, their growth uninterrupted. But recurring revenues are also strong, which poses the question, are employers really laying off?

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Outside of housing (real estate, mortgage, home improvement, furniture, etc.) and financing (wall street, mortgages), most people are doing OK. Unemployment is still fairly low. Most teachers are still teaching, most police officers still policing, most doctors still doctoring, most accountants are still counting, etc. In fact, even Wall Street has still not shed jobs significantly, at least not outside of any mortgage subsidiaries.

Pay check services won’t decline until employment declines. Plus as you mentioned, these firms are also growing their business by acquiring new accounts. Pay check services companies are in effect great early predictors of declining employment; there are even indexes based on pay check services companies data. It is not an insignificant commentary to note that these services are not yet in decline. It would be even more interesting to tease out the delta between internal sales growth vs external macro economic impacts on the business. Not only could we truly see what happening at the pay check services companies, we’d have better visibility on what’s happening in the broader economic world.

At this moment, most people are experiencing the effects of inflation stimulated by worldwide increased demand for most commodities (oil, food, building materials, etc); more than the effects of any upcoming recession. Unless the economy gets back on track, this may change as early as this year.

Realtosh Tuesday, February 26, 2008 at 4:51 PM PT

I’m not sure payroll companies are as vulnerable to big layoffs. The displaced workers don’t disappear- they usually go somewhere else and work. In fact, many open new small businesses/franchisees which prefer to out-source.

Insider Wednesday, February 27, 2008 at 9:53 AM PT

That doesn’t sound right to me. Unemployment generally rises during weaker economic times.

Sramana Mitra Wednesday, February 27, 2008 at 11:47 AM PT

So are check services companies growing because of an economy that is not in fact yet so weak that jobs have been shed, or are they growing because of strong sales effort?

Realtosh Wednesday, February 27, 2008 at 5:29 PM PT

Mostly because there is still a lot of under penetrated addressable market out there … and as a result, due to their sales efforts.

Sramana Mitra Wednesday, February 27, 2008 at 6:18 PM PT

How about businesses that have always processed payroll/tax filing inhouse with 3+ full time employees–they can take 2.5 FTE’s and move them to an internal profit center rather than overhead? Makes sense to outsource redundancy…

coco Wednesday, February 27, 2008 at 8:42 PM PT

As I read the news (BofA’s downgrade to nuetral) and posts in this forum, it amazes me that so many people seem to think that companies workforce reduction (layoffs) is a direct reduction in ADP or PayChex revenues. The “per-check” piece of the revenue is just not that big. The number of companies processing is much more important. In a recession, more companies, big or small outsource whatever they can to reduce fixed salaries. Trying to cut back on internal costs means more customers for payroll processors.

The biggest over-looked piece of the revenue is the fact that with lower short-term investment returns, they can’t make as much money on the float. As the Fed lowers interest rates that has a much more direct and immediate affect on profitability than a reduction in number of paychecks does.

Batitude Friday, February 29, 2008 at 2:36 PM PT

Anyone with access to ADP’s or Paychex’s internal numbers, or of an index based on such internal numbers, would not be surprised by today’s jobs numbers.

This discussion is not so related to the value of these check processing entities value as ongoing concerns. However, these comments are about the value of the data inherent in processing so many payrolls for so many companies in such a cross-section of industries.

It would be good for the Board of Governors at the Fed to have direct real-time access to the internal data of these check processing companies. It might help them get ahead of any fluctuations in employment to better manage the economy.

Realtosh Friday, March 7, 2008 at 12:15 PM PT

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