Home > Stock Analysis

The Trick Of Timing Paychex

Posted: Sep 30, 2008 11:12 AM by Stephen Simpson

Tickers in this Article: PAYX, ADP, ASF, INTU

I am willing to bet that everybody reading this has heard more than enough about the economic conditions in the United States and the arguments as to whether we are in a recession (or are soon about to be). Although I am not going to wade into that particular battle today, I think we can all agree that it is a critical issue for Paychex (Nasdaq:PAYX) - after all, when you make your money from processing payrolls for businesses, you have a vested interest in the business of business.

So Far, So-So
If you do accept the idea that Paychex is a bellwether for the health of small and mid-sized businesses (and not losing share to competitors like Automatic Data Processing (NYSE:ADP) or Administaff (NYSE:ASF)), then last week's earnings report will not leave you feeling too excited about a quick turnaround in the economy.

Get Free Stock Analysis By Email

The company reported that revenue rose about 5% for the quarter, with core payroll growth up 5%, human resources revenue up 16% and float income down 25%. The company managed to maintain margins, though, as reported operating income also rose about 5% for the quarter. (Learn more about the income statement. Be sure to take a gander at Find Investment Quality In The Income Statement.)

Storm Clouds on the Horizon
That sort of growth is admittedly not so bad, and although the company did lower its guidance a bit, management is still projecting overall revenue growth in the 6-8% range. The trouble is that that's just a projection; I don't question or doubt that management is being honest, but conditions can change faster or further than people expect (after all, that's why we have earnings surprises, right?).

Bankruptcy rates in the company's target markets are up about 10% from last year (though from a relatively small base), checks-per-client were down about 1%, hiring is sluggish across the economy (excluding the government), and banks are decidedly less inclined to offer business loans. None of that is good news for this company.

What's more, the company seems to be feeling pressure on its higher-margin activities. Historically, Paychex has been good at upselling (getting clients to add additional, more profitable, services) and that's a tougher sell when clients are coming under growing pressure to just pay the bills they already have. Secondly, the company is certainly seeing a different environment in managing its float (the money it collects, holds and earns interest on before paying out to clients' employees). This is admittedly not a huge part of the overall business, but it carries very high margins, and additional chaos in the credit markets could represent a one-two punch that hurts both the company's clients and its float management.

When To Step In?
As I see it, Paychex is one of those relatively rare businesses that earn solid returns on capital from a growing market. There are competitors, like ADP, Administaff, Intuit (Nasdaq:INTU) and so on, but there is a lot of business to go around, and Paychex has a long-established network of CPAs and banks that provide referrals. So, that's all good.

On the flip side, though, this company has undeniable economic sensitivity. If the economy continues to weaken, buying Paychex today could be like reaching out for a falling knife. Given that past banking crises have virtually always led to actual recessions (and not just "slowdowns"), my hunch is that you can wait to buy these shares. But eventually the economy will recover again, and Paychex is the sort of solid value-producing company that could be a good horse to ride.

For related reading on the economy, check out Do Tax Cuts Stimulate The Economy?

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

Rate this Article: Your Rating: Overall Rating: Vote Now!

MORE STOCK ANALYSIS