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Paychex Paints Pallid Picture

By Rich Smith - Updated Apr 5, 2017 at 7:56PM

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Of a U.S. economy on the wane.

Headline news: HR and payroll services specialist Paychex (NASDAQ:PAYX) reported Q2 results yesterday, and the news was not good (why the italics? I'll explain in a moment).

  • Q2 revenues grew 3% over last year's second quarter, a slight deceleration from the already anemic pace set in Q1.
  • Profits per diluted share declined 3% to $0.39 -- once again, a worse result than in Q1.
  • And guidance for the rest of the year is no better. Management predicts that we will cruise through fiscal 2009 on a 3% year-over-year rise in revenues, even as profits continue trending downwards by about 6%.

Growth-wise, the numbers convey few bragging rights. Still, these results show Paychex generating a 41% operating margin that dwarfs profitability at rivals Intuit (NASDAQ:INTU), ADP (NYSE:ADP), and Administaff (NYSE:ASF) (in that order).

Valuation
Despite analyst growth estimates that average out at 13% long-term, the stock trades for a 17 P/E and a 16 times ratio to its free cash flow. (Meaning that yes, Paychex generates more free cash flow than it gets to report as "net earnings" under GAAP.) Personally, I think Paychex is overpriced -- but that's just me. Lots of people disagree, including, notably, the analysts at both Motley Fool Income Investor and Motley Fool Inside Value. And maybe they're right. Investors do seem willing to pay a premium to own this stock, and its superior profit margins may explain why.

But that is not the news I'm talking about
Fact is, pretty much every time I look at Paychex, the shares look overvalued. So, the fact that Paychex still looks pricey is not really news. What is news in Paychex's report, and bad news at that ... does not actually pertain to Paychex at all.

You see, one of the advantages of following Paychex is that the company doesn't just tell you how it is doing in its earnings reports. It also gives us a snapshot picture of the health of the U.S. economy it services. Prognosis: not good. Quoting CEO Jonathan Judge's assessment:

"Over the past six months, we experienced companies going out of business increasing 12%, new business starts declining 13%, checks per client decreasing 1.5%, and we saw lower levels of new hire reporting."

Foolish takeaway
So, Staples (NASDAQ:SPLS) shareholders, listen up. UPS (NYSE:UPS) owners, you too. And everyone else, if over the coming days and weeks you find yourself hearing of increased weakness among other companies who count small businesses among their key clientele, don't say no one warned you -- because Paychex just did.

What did we expect out of Paychex last quarter, and what did we get? Find out in:

Administaff is a Motley Fool HG Pay Dirt selection. United Parcel Service and Paychex are Motley Fool Income Investor recommendations. Paychex and Administaff are Motley Fool Inside Value picks. Staples is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Paychex, Inc. Stock Quote
Paychex, Inc.
PAYX
$138.62 (0.22%) $0.31
Staples, Inc. Stock Quote
Staples, Inc.
SPLS
United Parcel Service, Inc. Stock Quote
United Parcel Service, Inc.
UPS
$204.98 (-0.66%) $-1.37
Automatic Data Processing, Inc. Stock Quote
Automatic Data Processing, Inc.
ADP
$260.69 (0.25%) $0.65
Intuit Inc. Stock Quote
Intuit Inc.
INTU
$478.30 (-2.02%) $-9.88
Insperity, Inc. Stock Quote
Insperity, Inc.
NSP
$114.54 (-1.07%) $-1.24

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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