Paychex Is Building Up; Take a Look

The fortunes of payroll processor Paychex (Nasdaq: PAYX  ) seem to be on the upswing as it posts a 7.2% growth in service revenue in the recently announced third quarter.

Although a weak economy and high unemployment rates may have made the company somewhat cautious in its outlook so far, the situation seems to be progressively getting better as the economy revives and as the company takes advantage of its recent acquisitions. Let's take a quick look.

Quarter roundup
Paychex's revenue increased to $569.5 million in the third quarter, helped by better sales in its payroll services and human resources divisions as compared to the year-ago period. While sales in the former division were boosted by better revenue per check, Paychex's human resources division benefited from a growth in checks per payroll that increased for the eighth consecutive quarter.  

This led to a 5.5% increase in sales of Paychex's payroll services, by far the largest contributor accounting for nearly 70% of total sales. On the other hand, the company witnessed a robust 12% rise in sales of its human resource services, as it benefited from new lines of business. Net income grew by 3.7% to $135.4 million, which translates into earnings of $0.37 per share that just met Street expectations.

Dodging challenges
Paychex caters to the small- and medium-size businesses that haven't been able to recover at the same pace as that of large companies post-recession. High inflation and increasing unemployment, combined with low interest rates, have hurt the growth of Paychex's clients. This has, in turn, restricted the company's client base expansion to some extent.

What has not helped either is the fact that Paychex faces cutthroat competition from industry rivals Automatic Data Processing (Nasdaq: ADP  ) and Insperity (NYSE: NSP  ) , both of which pose challenges to its pricing power and acquisition of new clients. In fact, Insperity posted revenue growth that was 14% -- higher than that of Paychex in its last quarter. However, Paychex is better off when it comes to profitability. The company has a high operating margin of about 38% as compared to ADP's 18% and Insperity's 3%.

Acquire and aspire
Within the past two years, Paychex has made two strategic acquisitions -- SurePayroll and ePlan Services -- that accounted for 2% of its quarterly top line and are expected to contribute even more in the future. SurePayroll has been a key to 30,000 clients and three big institutions such as Citigroup, SunTrust Banks, and Harris. Paychex is likely to further strengthen its position with the help of SurePayroll's latest user-friendly mobile application and ePlan Services' solutions for small businesses.

The Foolish takeaway
Paychex is slowly and steadily building itself up. The company has done reasonably well and has maintained consistent mid-single-digit growth despite operating in a dull market. The recent acquisitions are also likely to add significant value to the company. Time to keep a close watch on this one.

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Fool contributor Navjot Kaur does not own shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Paychex and Automatic Data Processing. Motley Fool newsletter services have recommended creating a write covered straddle position in Paychex. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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