A funny thing happened today: Payroll and human resource services provider Paychex (NASDAQ:PAYX) missed analyst estimates by a penny, but its stock rose nonetheless.
It might not be the usual reaction, but it's a fair one in this case. If you've seen the press release, you're well aware that quarterly revenues were up 15% and diluted earnings were up 25% to $0.30 per share, just shy of the $0.31 those clever analysts were expecting.
That's a nice performance, but I think investors are better served by also paying close attention to the company's operating earnings, which were up 19%. Those results don't include the company's substantial interest earnings; Paychex earns interest on its clients' deposits before it has to pay the cash out, much like the float at an insurance company. The client deposits are an important dynamic to consider here, but I prefer to exclude them when analyzing Paychex's overall operations.
The company didn't provide a statement of cash flows with its press release, but it did file its 10-Q with the SEC, which includes the cash flow details. Paychex delivered $401.6 million in free cash flow over the last nine months, a 23% improvement on last year's $325.5 million. In short, Paychex is performing exceptionally this year, and judging by the comments made in the press release about future customer sign-ups, next year should be similarly strong.
Of all the items in the press release, I'm most curious about the performance in the HR services portion of the business. Paychex saw revenues in HR services increase by 24% for the quarter and 31% for the first nine months of fiscal 2006. Administaff (NYSE:ASF) and GevityHR (NASDAQ:GVHR) focus on this area as well, and Administaff in particular has reported some very impressive growth so far this year. For now, at least, it seems that there's plenty of room for multiple players to expand in this arena.
Unfortunately, as much as I like Paychex, I don't consider it a purchase candidate right now. After running a back-of-the-envelope discounted cash flow analysis on the company, I think it's fairly valued. My most optimistic assumptions have it 10% undervalued, and my pessimistic assumptions estimate that it's 15% overvalued. I like to find companies that are obviously cheap, trading at least 20% below my pessimistic assumptions. For now, Paychex is one to watch, but it's not a place I'm ready to put my own money.
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Nathan Parmelee has no financial interest in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.
