The world's largest provider of outsourced payroll-processing services, Automatic Data Processing (NYSE:ADP), closed the books today on what has been, at best, a mixed fiscal year 2004. Full-year revenues rose 9% to $7.8 billion, but earnings slipped 7% lower to $1.56, a steeper decline than last year's 4% earnings erosion.
In some respects, the fourth quarter mirrored the year as a whole -- revenues were up 9%, but net income was slightly down. However, there were signs of strength: New business sales jumped 19% for the quarter, brokerage services revenues grew 5%, dealer-service sales rose 13%, and the average client payroll grew 1.5% larger -- all indicative of a strengthening economy and a workforce that has swelled by an average 211,000 workers per month over the past six months.
When Warren Buffett trimmed his position in Automatic Data Processing -- as well as several other companies, including Gannett (NYSE:GCI), Gap (NYSE:GPS), and H&R Block (NYSE:HRB) -- the rest of the investing world took notice. To be sure, for a man who seldom sheds his holdings, the rationale for selling was likely grounded in what he perceived as deteriorating fundamentals, questionable valuations, or some combination thereof.
Back-to-back down years bear out the validity of his assessment, but two of the underlying causes, an anemic job market and record-low interest rates, have shown improvement. Though ADP has branched into other services that target the financial, auto dealer, and insurance industries, the employer-services division (with 60% of revenues) still carries most of the weight. A firming job market will support this core business segment, which also markets tax filing, 401(k) administration, pre-employment screening, and workers compensation insurance.
Rising interest rates will also help boost future revenues. The firm temporarily holds money that is collected from 460,000 employer-services clients before it is redirected to the appropriate location. In the interim, substantial interest is earned, and an increase in short-term rates will only enhance that income.
With a broad-based economic recovery and only a handful of top-tier rivals such as Paychex (NASDAQ:PAYX), Administaff (NYSE:ASF), and Ceridian (NYSE:CEN), Automatic Data Processing should once again prosper, especially without being weighed down by high unemployment, low interest rates, and poor stock market performance. The company generates plenty of free cash flow (more than $1.3 billion annually) and loves to repurchase stock (fewer shares outstanding now than a year ago). The past two down years should create easy earnings comparisons going forward -- particularly for a firm that until then had delivered 41 consecutive years of double-digit earnings growth.
For a more in-depth look at both ADP and Paychex, read Selena Maranjian's Paychecks From Paychecks.
Fool contributor Nathan Slaughter owns none of the companies mentioned.
