Recent results at payroll and human resources services provider Paychex (Nasdaq:PAYX) demonstrated that, while it is having little problem in staying profitable during one of the most severe employment contractions in its history, its growth trends are a far cry from what investors have come to expect from the nimblest firm in the industry. However, there is considerable upside for shareholders if Paychex can return to its double-digit growth days.
IN PICTURES: Eight Ways To Survive A Market Downturn
Recent Results
Total first-quarter revenue fell 6% to $500.2 million, as service revenue, which consists of the flagship payroll services and newer human resources service revenue. Payroll accounted for 70.8% of quarterly revenue and fell 6% while HR made up 26.4% and eked out 1% growth. The rest of revenue consists of interest Paychex earns on payroll and other funds held for clients. A much lower interest rate environment cut this lucrative segment 43%, to $13.7 million, or 2.7% of total revenue.
Expenses were held somewhat in check, falling 1% for the quarter, but did not prove sufficient in offsetting the challenging top-line trends. Management attributed this to "overall cost control measures and stable headcount, offset slightly by costs related to continued investment in key areas of our sales force and our technological infrastructure." As a result, operating income fell 14%, to $189.9 million and lower investment income served to push earnings down 17%, to 34 cents per diluted share.
Yet despite the negative growth trends, Paychex remained fantastically profitable and posted a 24.7% net margin for the quarter. Operating cash flow also shrunk, falling 14% for the quarter but free cash flow exceeded reported net income, coming in at approximately 49 cents per diluted share as the company requires very little capital expenditures to grow and maintain its services businesses.
Competitive Landscape
Archrival ADP (NYSE:ADP) posted a 5% revenue decline in its most recent quarter as payroll revenue fell 5.3% and professional employer organization revenue, which is similar to Paychex's HR segment, posted a 6.6% increase in revenue. ADP saw 2% operating income growth and a 7% increase in earnings from continuing operations.
Both Paychex and ADP are doing well in their non payroll services as rival Hewitt Associates (NYSE:HEW), which specializes in human resources consulting and outsourcing, posted a 6% decline in net revenue. However, it did post a nice increase in earnings and cash flow on cost controls and a lower income tax rate.
The Bottom Line
Paychex expects total revenue to fall in the low single digits for the full year as interest on client funds should plummet up to 30%. But HR service revenue should grow slightly and partially offset the 5-7% projected decline in payroll services. The end result should be a 10-12% fall in net income. Analysts currently project full-year earnings of $1.31 per share.
At a current share price just below $30, Paychex is trading at a forward P/E of over 22 times. This is toward the low end of its five year historical P/E range of 14-41 times, and Paychex should also return to the double-digit average earnings growth it has posted over the past five years. The stock price is currently discounting about 9% free cash flow growth over the next decade, so if Paychex can post 10% or higher growth, there is at least 25% upside from current levels. (For more, read Sell Growth Stocks The IBD Way.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
