ADP’s Long-Term Growth To Be Driven By Demand In The PEO Space

ADP (NASDAQ:ADP) has been a consistent leader in the human capital management space over the years, with a strong presence in payroll processing, employer services and other HR services. The company’s core client base consists of large corporations, with small and medium businesses making up a smaller proportion of the client base. ADP has witnessed high single digit revenue growth over the last few years, with fiscal 2016 revenues growing at 7.4% to $12.5 billion. ADP’s PEO services business drove much of that growth, due to a 12.2% revenue increase to $3.4 billion in the fiscal year ended June this year. The company has witnessed a mid teen percentage revenue growth in PEO services over the last few years driving much of the top line growth in the period. Growth was driven by a corresponding increase in the number of total HR worksite employees in the period, as shown below.

We expect this trend to continue in the long run, and as a result HR Outsourcing and Services makes up around 10% of our revised $87 price estimate for ADP’s stock. Our current price estimate is roughly in line with the current market price.

See our complete analysis of ADP Here

Revenue And Margin Forecast For FY 2017

ADP is one of the largest providers of payroll information, tax-filing services and organizing pension schemes under its Payroll Processing division. Additionally, the company offers Professional Employer Organization (PEO) service, which includes outsourcing solutions based on co-employment and covers services such as payroll, tax-filing, 401K retirement savings plans, health and benefits services and insurance. The core payroll processing business forms a huge chunk of ADP’s net revenues, with roughly $8.2 billion generated in revenues out of ADP’s 11.7 billion total revenues in fiscal 2016. Payroll processing (or employer services) revenues have grown at a steady 4-5% over the last few years. Comparatively, HR outsourcing and services (or PEO services) have grown at a CAGR of almost 15% in the last five years. Growth was driven by a surge in the number of clients served by the company as shown above. We currently forecast the trend to continue with a similar growth rate expected in FY 2017.

ADP’s cash operating expenses have increased roughly in proportion to its revenue growth over the last few years. As a result, the company-wide operating profit (adjusted for non-cash expenses) has grown at just over 5% in the last five years – slightly higher than the revenue growth. As a resulted, the adjusted EBITDA margin has improved from 20.3% in 2013 to 21.4% in 2016. We expect the trend to continue as shown below, with revenue growth in the clients interest funds driving the EBITDA growth and subsequent improvement in margins.

Long-Term Forecast For PEO Services

The total number of ADP’s HR worksite employees outsourcing clients have grown at 14-15% in the last five years, driven by an increase in new business bookings. Moreover, after the deadline for adherence to provisions of the PPACA having passed in January last year, the adoption of ADP’s products catering to the regulation further increased, subsequently driving up its client base. According to research by ADP last year, about half of large employers (1,000+ employees) in the U.S. were unprepared to comply with the regulations of the PPACA around the beginning of 2015. ^[1] As a result, ADP witnessed strong activity in this space as clients chose providers to help them implement ACA solutions. This could continue to fuel demand for HR services in this domain. We forecast ADP’s total worksite employees to continue to increase, albeit at a slower pace to over 650,000 employees by 2022.

Similarly, we forecast ADP’s average revenue per worksite employee to increase from $7,100 through fiscal 2017 to over $8,100 by the end of our forecast period. You can modify the interactive charts below to gauge the effect a change in the total customers or average fee per client will have on our price estimate for the company.

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