ADP’s Fundamentals Support $57 Value, New Offerings Will Drive Growth
Automatic Data Processing (NASDAQ:ADP), the world’s largest payroll processor, reported strong revenue growth of 13% to $2.5 billion in its recent third quarter earnings. However, the stock dropped as seesawed following earnings as operating margins shrank and the company expected lower revenue growth of 7-9% for the full year. We believe the concerns for ADP are overdone as it’s core business remains sound. ADP competes with other payroll processors like Paychex (NASDAQ:PAYX) in the US.
We have a $57.67 Trefis price estimate for ADP, about 10% above the market estimate, based on our DCF valuation model. Below we take a look at some of the key take aways from ADP’s earnings.
Key Metrics Strong for ADP
ADP’s strong revenue growth during the quarter resulted from both strong new business sales and recent acquisition. Additionally, all key business metrics continued to trend positively, namely new business sales, client revenue retention, the number of employees on clients’ payrolls and client balances.
While sales in national accounts and international business were a bit soft for the quarter given the economic uncertainty of recent months, small business services, the PEO, major account services and added value services, all achieved double-digit sales growth in the quarter. Also, employer services and PEO services new business sales grew 8% year-over-year.
More importantly, ADP’s client revenue retention increased across the firm’s operating segments – employer services, PEO and dealer services, after improving over 1 full point for fiscal 2011. Additionally, U.S. pays per control (or average employees serviced per payroll account), roughly the same-store sales equivalent employment metric, was up 2.7% in the quarter. This is a positive development for ADP as can be seen in the chart below.
Average work site employee paid in the PEO grew an impressive 13% in the quarter and we expect this number to continue to grow as ADP expands its services portfolio.
Margins expected to recover
ADP’s total pretax margin declined 140 basis points in the quarter, primarily resulting from a decline in high margin client interest revenues due to a lower yield on the balances. The decline from the client fund investment strategy resulted in a drag of 85 basis points on ADP’s pretax margin. In addition the acquisition from last year had a negative impact of about 40 basis points on the pretax margins.
While the yield on the client fund portfolio is expected to be lower in fiscal 2012 at 2.7% to 2.8%, it will be partially offset by an expected increase of 7%-8% in ADP’s client funds balance. Client funds balance grew 10% in first quarter.
Also the negative impact from acquisitions is expected to decline during the year as several transactions close and their contribution to revenues increase.
The RightThing to do
ADP is focused on expanding its services portfolio and recently acquired The RightThing, the market leader in recruitment process outsourcing solution, and will be targeting large companies with over 15,000 employees with this new offering.
With a strong client base to leverage, the new acquisition is certainly a step in the right direction for ADP and can be expected to provide a significant boost to the company’s top line in the future.
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