The coronavirus pandemic has hit a lot of small and mid-sized businesses hard. These are the types of companies that Paychex (PAYX -2.53%) provides with payroll, human resources, retirement, and insurance services through its platform.
Is the company well-positioned to help its clients through these uncertain times while maintaining solid earnings growth? Let's look at where Paychex stands and whether it's a buy.
Acquisition helps boost earnings
Paychex has been a solid performer, with an annualized return of 10.7% over the last 10 years and 13% over the past five years through Dec. 31, 2019. Last year it beat the S&P 500, returning nearly 35%. This year, the stock is down about 18% as of midday Wednesday.
In the third quarter of its fiscal 2020 (which ended Feb. 29), the company reported a revenue increase of 7% from the previous year's quarter to $1.1 billion.
Paychex got a revenue boost from its acquisition of Oasis Outsourcing Group in December 2018. Oasis is a professional employer organization, or PEO, which enables companies to outsource human resources, employee benefits, payroll, and risk management services. Paychex's revenue from this segment was up 10% in the quarter to $271.5 million, driven by growth of the client base.
The larger management solutions business -- where the company provides payroll and human capital management solutions through its platform -- saw revenue jump 6% to $850 million for the quarter, driven by gains in new clients and deepening offerings with existing clients, particularly in the areas of retirement services, among others.
Overall, net income increased 9% to $354.5 million while earnings per share (EPS) climbed 9% to $0.98 per share year over year.
Weathering the storm
Because Paychex's third quarter ended before most states implemented stay-at-home policies, its strong earnings results do not, for the most part, reflect the extent of the disruption caused by the COVID-19 pandemic. However, the company made a number of technology-based upgrades over the past year and a half that will help clients navigate the challenges.
One of the upgrades is called HR Conversations, which allows employers to two-way-message remote workers through its mobile app. Another new feature is called Pay-on-Demand, which lets employers pay workers more quickly and provides the flexibility to pay on various shifts. In addition, the new Paychex Flex Help Center gives clients access to training resources using predictive learning and natural language processing.
"The significant investments we've made in our technology, and in particular our mobile app, and our expanded product and features in our service model options, allow us to support our clients in any environment," Paychex President and CEO Martin Mucci said on the third-quarter earnings call on March 25.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which became law last December, should also present Paychex with additional opportunities for growth. The law provides incentives for employers to offer retirement savings plans, and, as a leader in 401(k) recordkeeping services, Paychex is well-positioned to help clients and gain new ones.
What's the outlook?
As it moves through the fourth quarter of its fiscal 2020, which ends May 31, Paychex anticipates annual revenue growth of 8% to 9% for the full year. Net income and diluted earnings per share are expected to rise 7%. The company also projects a robust 36% profit margin and 41% EBITDA margin for the full year. In the fiscal fourth quarter, revenue is expected to be down slightly due to the impact of the COVID-19 pandemic on small businesses.
The guidance includes estimated effects from the pandemic and the zero-bound interest rate environment, but given the unprecedented uncertainty, officials acknowledge that it could change. "So far, we've seen minimal changes in our key metrics. However, with the expanding shutdowns of businesses throughout the nation, we do expect that this will be particularly challenging time for small and mid-sized businesses," Mucci said in the March 25 earnings call.
Paychex will provide guidance for fiscal 2021 next quarter, but CFO Efrain Rivera said a preliminary view reveals flat to low-single-digit revenue growth. That's roughly $20 million below 2020, with an anticipated profit margin of about 35%. The preliminary forecast is for a rocky Q1, followed by improvement in Q2 and Q3 and recovery in Q4.
The good news is Paychex's financial position is sturdy, with cash, restricted cash, and corporate investments totaling about $930 million. Cash flows from operations are $1.1 billion for the nine months of the fiscal year, an increase of 3% from the previous year. That ample liquidity, along with access to short-term financing, will support "normal business operations, capital purchases, share repurchases, and dividend payments for the foreseeable future," said Mucci.
Paychex's price-to-earnings (P/E) ratio has taken a dive in this crisis, recently rebounding to near 23 -- still comfortably below its recent levels. At its current valuation, and with its added scale and outlook for sustained growth, Paychex should get through this in pretty good shape and remain a solid long-term investment.