Recession-Proof Stocks: Paychex

Looking for more juicy dividend stocks to weather a recession? Check out our special series on recession-proof stocks.

Payroll processor Paychex (Nasdaq: PAYX  ) has a wonderful business model that benefits from scale and network advantages. It plays second banana to industry giant Automatic Data Processing (NYSE: ADP  ) , but it's double the size of the next largest competitor, Ceridian (NYSE: CEN  ) .

But being second banana here is an advantage for investors, because Paychex has much more room to grow. In fact, over the past five years, Paychex has grown revenues at around 14%, while ADP has struggled to grow at all. Better still, the expectation that we're heading into a weaker labor market has dropped the share price by more than 30% since its high last August. Now the stock is significantly undervalued, and it's easy to see what the rebound will look like once we head out of the recession.

Paychex raises
Everyone loves a pay raise, and naturally, investors like raises, too. So here's what makes Paychex a compelling pick to give you that financial boost:

  • The company has fabulous returns on equity and capital, achieved without the use of debt.
  • It has no need to raise capital during the credit crunch, because it has a fortress-like balance sheet.
  • It requires minimal capital expenditures to grow its business.
  • It has growth opportunities, both by increasing penetration in the payroll market and by using its vast network of established client relationships to sell additional services. Analysts polled by Reuters -- a part of Thomson Reuters (NYSE: TRI  ) -- expect 14% growth over the next five years.
  • It pays a dividend yielding 3.8% and has used excess cash to buy back shares.
  • Founder and Chairman B. Thomas Golisano owns 10.6% of shares outstanding.

Paychex deductions
No company is a perfect employer or a perfect investment, and Paychex is no exception. So here are the risks:

  • Paychex concentrates on small and mid-size businesses, and in the short term, a prolonged recession tends to hurt smaller businesses disproportionately. The current environment makes it unlikely that the company will achieve that 14% estimated growth.
  • It earns significant amounts of interest on the payroll float (interest income makes up 17% of operating income) and is therefore at risk to lower short-term interest rates. Conversely, the company benefits if those rates rise.
  • In a recession, companies cut payroll. Lower-than-expected payrolls and a long recession could see the shares get cheaper.

Foolish Paychex
The Motley Fool's mission is to educate, amuse, and enrich, and that's precisely what this article is about. Ignore my attempts at humor if you will, but don't ignore the opportunity to educate yourself about Paychex and enrich yourself by buying its shares. We almost always get more opportunities to buy cheap shares, but don't wait too long, because this company is bound to be a leader coming out of a recession.

Before you make a buy decision, check out what our CAPS community of more than 110,000 investors thinks. And don't stop there. Chime in with your own CAPS call on whether Paychex will outperform or underperform.

Philip Durell is the advisor/senior analyst for The Motley Fool's Inside Value newsletter service. He owns none of the companies mentioned in this article. Thomson Reuters is an Inside Value recommendation. The Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (13)

Comments from our Foolish Readers

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  • Report this Comment On June 28, 2008, at 12:23 PM, rrrishi wrote:

    High interest rates might help PAYX deliver higher income from the interest it earns but it will lose small business clients as macro economic conditions will continue to worsen. B & C grade office space vacancy rates are expected to continue to climb rapidly (Small business users). I don't think PAYX is immune to a deep recession. It may only be immune temporarily to a credit crisis. Not the potential outcome of high interest rates that send small busineses in bankruptcy. During the Conference call the CEO diminished thoughts of a new buy back. I wouldn't be a buyer of any stock in a market that has commodity prices escalating at a faster pace then ever. This stock deserves a higher risk premium as its business is the epi-center of thousands of small businesses which are sensitive to interest rate hikes as they borrow money on credit to expand operations.

  • Report this Comment On June 28, 2008, at 1:01 PM, TMFAdmiral wrote:

    Hi rrrishi,

    I agree with your comments - however the main point of the series was "best stocks coming out of a recession"

    And I certainly think that Paychex will succeed there - As I said in my article the stock could get cheaper

    Regards

    Philip

  • Report this Comment On June 30, 2008, at 4:33 PM, rrrishi wrote:

    Coming out of a recession? Its funny. Some reports show the US is in a weak economy not yet recession. Others state we are in a recession. Some even think a depression is possible. The actual truth is something we don't really know. This is an unusual crisis that seems like a credit crisis spreading to even AAA companies like GE. I mentioned that PAYX had a tough time obtaining credit. Overall, I think its too early to call any trades coming out of a recession because until statistics don't prove we are facing severe inflation in a recession, the bottom will not be found in equities. And that dividend that we all buy stocks for can gradually start declining. I'm worried about a global slowdown causing an even heavier equity sell off in the coming weeks. Its tough to buy bargains because we don't know when the market makes it a closeout!

  • Report this Comment On July 10, 2008, at 2:28 PM, Robert685 wrote:

    I agree with you rrrishi. This is indeed an unusual crisis.

    I mean, come on, in 2004 If I told you that Citigroup (C) would be trading at $16, mid 2008, you'd of had me committed. Or that Bear Stearns would NO LONGER EXIST!!! Surely you'd have taken me out in a straight jacket on that one.

    Crisis is not even CLOSE to what we are about to experience.

    According to the National Bureau of Economic Research.

    http://www.nber.org/cycles/

    the worst recession (in my life time) occurred November 1973--March 1975-Contraction Peak to Trough lasted 16 months

    We'll be LUCKY to see this through in 24 months.

    The next big crash is going to be ENORMOUS defaults on Credit Cards.

    We've seen UNHEARD OF, RECORD numbers of individuals willing to simply "give up" and walk away from their homes. Do you HONESTLY believe that the sub-group of Americans carrying a balance (and 12% paying the minimum) are going to continue to "fight" to survive as banks continue to RAPE individuals with 26%-30% interest rates?!!

    People struggled with 7,8,9% up ticks with home Mortgages.....

    Mark my words...the next CATASTROPHIC COLLAPSE will be in the Consumer Credit Card industry.

    Take a look at some of the recent polls.....

    June 11, 2008

    Nearly One-Third of Credit-Card Owners Hold High Balances

    http://www.gallup.com/poll/107833/Nearly-OneThird-Americans-...

    25% acknowledge that they usually leave a balance and 12% say they usually pay only the minimum amount due each month (1% pay less than the minimum).

    Early June Has 86% Saying U.S. Economy Is Getting Worse

    http://www.gallup.com/poll/107797/Early-June-Has-86-Saying-U...

    June 3, 2008

    Record-High 55% of Americans “Financially Worse Off”

    http://www.gallup.com/poll/107647/RecordHigh-55-Americans-Fi...

    An ALARMING! 1/3 of Americans have no faith in their children's financial future.

    June 9, 2008

    In U.S., 28% Say Their Kids Will Be Worse Off

    http://www.gallup.com/video/107704/Perceived-Standard-Living...

    July 10, 2008

    Early July Views of U.S. Job Market Suggest More Losses

    http://www.gallup.com/poll/108730/Early-July-Views-US-Job-Ma...

    June 23, 2008

    Confidence in U.S. Banks Down Sharply

    Only 32% of Americans express confidence in U.S. banking institutions

    http://www.gallup.com/poll/108229/Confidence-Banks-Down-Shar...

    June 17, 2008

    Fuel Prices Now Clearly Americans’ No. 2 Concern

    http://www.gallup.com/poll/108067/Fuel-Prices-Now-Clearly-Am...

  • Report this Comment On July 10, 2008, at 2:54 PM, Robert685 wrote:

    Not good for ADP, Paychex or Ceridian:

    http://www.adpemploymentreport.com/pdf/FINAL_Report_June_08....

    In June, construction employment dropped 34,000. This was the nineteenth consecutive monthly decline, and brings the total decline in construction jobs since the peak in August of 2006 to 349,000

    Employment – June Payrolls Dropped by -62K

    https://reports.us.bk.mufg.jp/portal/binary/com.epicentric.c...

    In June, payroll employment decreased by another -62K jobs, while downward revisions to the prior two months of data subtracted -52K jobs from the economy.

    The 3-month moving average for jobs growth declined by -64K in June compared to an average decrease of -72K in May, and an average decrease of -79K in April. Payrolls have now declined for six consecutive months, which is the longest consecutive monthly decline since the start of the 2001 recession.

    ADP National Employment Report found that total nonfarm private employment likely dropped by -79K in June.

    The consensus forecast collected by Bloomberg showed economists were expecting -62K net jobs in June.

    In June, total private jobs declined by -91K with the private service sector shedding -22K jobs compared to a drop of -37K in May, while the goods producing sector subtracted -69K jobs compared to -54K in May.

    Facing a tough economic environment, retailers cut another -8K jobs in June, shedding jobs for a seventh consecutive month.

    A harbinger of broad employment trends, temporary help service jobs, fell by -30K in June, and have contracted for eighteen consecutive months, though the rate of loss has not accelerated. Temporary help jobs are the first to go when the labor market is slowing. Voluntary job leavers (as a percent of unemployed) dropped to 9.9 percent in June, showing employees’ faith in job prospects deteriorated further over the month.

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