Payroll Sector Improving

The employment situation in the Unites States is slowly improving: for the third straight month, ADP (NASDAQ:ADP) reported positive job growth. According to the company’s national employment report, private sector jobs increased by 32,000 in April, more than the 20,000 expected by economists. This is a positive sign for the payroll industry. The official report from the U.S. Bureau of Labor Statistics, which includes public sector jobs, confirms this positive trend with the fourth consecutive report of job growth and addition of about 290,000 jobs in the month. Let’s take a closer look at the recent performance of Paychex (NASDAQ:PAYX) and ADP.

In March Paychex, with annual revenue of $2.1 billion, reported third quarter revenue of $507.8 million, down 4% y-o-y. Net income was down 14% to $112 million or $0.31 per share.

The company’s client base has declined 2.1% since May 31, 2009. Paychex’s Payroll Services revenue decreased 6% to $358.3 million, but checks per client remained stable at a decline of just 2.2% in the quarter, versus 3.7% in Q210 and 5% in Q110. Human Resource Services (HRS) revenue increased 3% to $135.5 million. In October, Paychex sold Stromberg time and attendance solutions to Kronos, and excluding Stromberg, HRS revenue would have been increased 10%. Health and Benefit Services revenue increased 54% to $8 million.

Paychex considers its Major Market Services segment with its SaaS solution to be a strong area of opportunity. However, to accelerate its growth in SaaS, it should look at making some acquisitions. Paychex has a strong financial position with cash and total corporate investments of $689 million and no debt. However, it has been slow to make acquisitions. An attractive prospect would be Intaact, which provides on-demand financial management applications to over 2,500 small and medium-sized businesses. In the small businesses segment, Paychex faces an increasing challenge from Paycycle since the latter’s acquisition by Intuit.

Paychex maintained its earlier outlook and expects revenue in 2010 to decline 2% to 5% to a range of $1.98 billion to $2.04 billion and earnings to decline 10% to 12%. The stock is currently trading around $28.95 with market cap of about $10.46 billion. It hit a 52-week high of $32.88 on December 4.

ADP, with nearly $9 billion in revenue, reported a third quarter revenue increased of 3% to $2.4billion. Net income was $401.6 million or $0.80 per share, about the same as last year. The company bought back shares for $280 million and ended the quarter with $2.1 billion in cash. Q2 coverage is available here.

Client retention levels improved 1.4 percentage points but are not yet back to levels from several years ago. The pays per control (the number of employees that clients pay) metric declined 2.5%, but the pace of the decline has slowed. ADP said that sales to larger companies in the United States are still lagging somewhat from a year ago, but sales to small and midsized companies are increasing. The progress is a positive sign, and ADP began to expand sales force and plans to increase its sales force of 4,000 by 300 to 400 people.

ADP closed four acquisitions in its Employer Services segment during the quarter, which will add over $10 million in revenues this fiscal year. Employer Services Q3 revenues increased 1%, nearly all of which was organic growth. PEO Services’ revenues increased 15%. Dealer Services’ revenues declined 3%, 4% organically.

For fiscal year 2010, ADP expects revenue to be about flat with last year and EPS of $2.36 to $2.38. The stock is currently trading around $41.56 with market cap of about $21 billion. It hit a 52-week high of $45.74 on April 26, right before the results announcement.

Unlike Paychex, ADP has been making strategic acquisitions in the SaaS space, including HRinterax, an HR content and support services company and DO2, an electronic invoicing company. The company has about $2.1 billion in cash and continues to look for strategic opportunities. Another attractive acquisition would be Salary.com, which has about 3,500 enterprise customers.