A Service Company with Steady Growth

Paychex (NASDAQ: PAYX  ) offers payroll, human resource, and outsourcing services for small to medium-sized businesses. The company's goal of driving growth in clients, revenue, and profits via industry-leading technology and outstanding service is working. But that doesn't mean it's the best investment in its peer group.

Growth and expectations

Paychex aims for product portfolio expansion and acquisitions for growth. For instance, it recently launched mobile apps for smartphones, and added access to flexible spending accounts, as well as health and benefits information.

Paychex is also expanding beyond the United States and Germany, and is now moving into Brazil after forming a joint venture with Semco Partners in order to provide HR services to small businesses. This might not be a major move in regards to geographical expansion, but it may be a sign of things to come. Paychex sees economic growth and opportunity in Latin America, and it's likely to capitalize on that trend going forward. With no long-term debt whatsoever and capital preservation a focus, Paychex is well-managed in a fiscal sense and can afford such growth risks.

Looking back at FY 2013 over 2012, revenue growth is apparent. Payroll Service revenue (payroll processing, payroll tax administration services, regulatory compliance services) improved 2% to $1.5 billion. Human Resource Services revenue (administrative services, professional employer or organizational services, customer support for employee-related topics) jumped 10% to $746 million. Total revenue increased 4% to $2.3 billion.

Looking ahead to FY2014, Paychex expects revenue growth of 3%-4% in Payroll Services, 9%-10% in Human Resource Services, and 5%-6% in Total Services.

Client base totals over the past three fiscal years indicate a positive trend:

  • 2011: 564,000
  • 2012: 567,000
  • 2013: 570,000

Net income also improved by 4% to $569 million, and diluted EPS increased 3% to $1.56. Paychex expects net income to grow by 8% to 9% for FY2014.

All of the above is impressive, and considering the company's strong historical track record, future goals look to be attainable barring a complete economic collapse. In addition to the growth vehicles covered above, Paychex is well positioned for the SaaS (software-as-a-service) boom, as it offers human resource management, employee benefits management, time and attendance systems, online expense reporting, and more.

Paychex also launched a report center and report writer (on-demand reporting needs and data extract templates) and a new BuildMyBiz.com (small business and entrepreneur resources). Those looking for health care reform information can also visit Paychexinsurance.com.

Important notes:

  • Thanks to advanced technologies and high customer satisfaction, Paychex has managed to retain 81% of its Payroll Services clients.
  • 84% of net income is paid to shareholders via dividends

At this point, it might seem as though considering peers of Payche for investment would be a waste of time, but you never want to leave any stone unturned.

Paychex vs. peers

As indicated above, Paychex has seen steady growth, and expectations are solid going forward. However, other companies in the space also have high expectations. For instance, Automatic Data Processing (NASDAQ: ADP  ) expects revenue growth of 7% and EPS growth of 8%-10% in FY2014. This human capital management solutions company also holds the #65 spot on Forbes 2013 "World's Most Innovative Companies" list. Paychex didn't management to crack that list.

Then there's Intuit (NASDAQ: INTU  ) , which expects FY2014 revenue and EPS growth of 6%-8% and 10%-13%, respectively. For a more specific breakdown, the company's recent realignment is expected to lead to 3%-5% revenue growth in its Consumer Group segment, 10%-12% revenue growth in its Small Business Group segment, and 0%-4% revenue growth in its Professional Tax segment.

If you look at the all-time historical stock performance for these three companies, Intuit is the best long-term performer of the group.

INTU Chart

INTU data by YCharts

However, it should be noted that Automatic Data Processing was the most resilient of the three at the height of the Great Recession, mostly due to its larger size, with the stock dropping approximately 20%, versus 30% for Intuit, and 40% for Paychex. All three stocks held up relatively well compared to the carnage seen throughout the broader market at the time.

Currently, all three stocks have similar valuations, with Paychex trading at 25 times earnings, and Automatic Data Processing and Intuit trading at 25 and 22 times earnings, respectively. Paycheck does yield 3.60%, compared to 2.40% and 1.10% for Automatic Data Processing and Intuit.

Conclusion

All three companies mentioned in this article are likely to be long-term winners. In all three cases, you have quality management and strong guidance. As far as Paychex goes, the biggest concern doesn't relate to any company-specific matters, but the broader economic environment. Though the stock is somewhat resilient on a relative basis, nobody aims for losses. With the global economy on questionable ground and the stock market potentially overextended, this might not be the ideal entry point for Paychex. However, an investment in a strong underlying company will almost always work out in the end. If you plan on investing, consider doing so at an incremental pace so you can add to your position if the stock suffers downside moves.

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