Paycom Software (PAYC 1.24%) and Workday (WDAY -1.19%) both digitize human capital management (HCM) services with cloud-based tools for managing payrolls, employees, expenses, and digital documents. Paycom started out as an online payroll services company and expanded its ecosystem with more HCM services. Workday started out as a cloud-based finance and human resources (HR) services provider before adding more HCM tools and student information services to its platform.
Paycom and Workday both saw their stocks close at record highs during the peak of the growth stock rally in November 2021. However, Paycom's stock subsequently plunged more than 60% while Workday suffered a milder decline of 8%. Let's see why Workday held up so much better than Paycom -- and if it will remain the better HCM investment for 2024.
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Paycom faces severe cannibalization issues
Paycom's revenue rose 25% in 2021 and 30% in 2022. However, it expects its revenue to rise just 22% in 2023 and 10% to 12% in 2024. That slowdown was caused by two major challenges.
First, the macro headwinds drove many companies to rein in their software spending. Second, its new platform, Beti, which automates payroll services through self-service tools, grew increasingly popular in the tougher macro environment because it cost less than its older services.
Beti delivered a higher return on investment for its clients, but it also generated lower revenue per customer by eliminating certain billable items. As a result, Beti started cannibalizing Paycom's older products and throttling its total revenue growth.
During Paycom's latest conference call, CEO Chad Richison said that nearly two-thirds of its clients had switched to Beti. However, CFO Craig Boelte admitted that Beti was "cannibalizing a portion" of its services and unscheduled revenue -- and that shift forced it to provide its "prudent" revenue outlook for 2024.
Analysts expect Paycom's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to rise 22% in 2023 and 9% in 2024. That outlook implies its adjusted EBITDA margin will slip from 42% in 2023 to 41% in 2024 -- which suggests the growth of Beti will crimp its near-term margins as well as its revenue.
That near-term outlook seems grim, but Beti's long-term growth could lock in its customers and gradually widen its competitive moat. Its stock also looks historically cheap at 6 times next year's sales and 14 times its adjusted EBITDA.
Workday faces fewer near-term headwinds
Workday's revenue rose 19% in fiscal 2022 and 21% in fiscal 2023 (which ended in January 2023). It expects its subscription revenue (which accounts for most of its top line) to grow 19% in fiscal 2024 and rise another 17% to 18% in fiscal 2025. Analysts expect its total revenue to rise 17% in fiscal 2024 and grow 16% in fiscal 2025.
Workday also faces a near-term slowdown in this tougher macro environment, but its subscription backlog is still growing and its margins are expanding. Analysts expect its adjusted EBITDA to rise 27% in fiscal 2024 and 19% in fiscal 2025 -- which implies its adjusted EBITDA margin will expand from 25% in fiscal 2023 to 28% in fiscal 2025.
That outlook suggests its growth will stabilize and accelerate once the macro environment improves. Its net revenue retention rate -- which gauges its year-over-year revenue growth per existing customer -- also remains comfortably above 100%.
During its latest conference call, co-CEO Carl Eschenbach said that businesses will continue to use its services to "reskill and upskill their workforce" to "scale and drive productivity" amid the recent macro challenges. CFO Zane Rowe also said it will focus on making "incremental investments across our key growth initiatives" -- including artificial intelligence (AI) tools for streamlining HCM tasks -- while "delivering continued margin expansion as we scale and optimize the business."
Workday trades at 8 times next year's sales and 28 times its adjusted EBITDA. It might seem pricier than Paycom, but its stronger growth rates, expanding margins, and lack of cannibalization issues arguably justify that higher valuation.
The better buy: Workday
Paycom's expansion of Beti might eventually pay off, but it will likely weigh down its stock until a few green shoots appear. Unless that finally happens, Workday will remain the better overall investment in the growing HCM market.
