INVESTMENT THESIS
We are maintaining our BUY rating on Paychex Inc. (NGS: PAYX) and raising our target price to $103 from $92.
RECENT DEVELOPMENTS
PAYX shares have underperformed the market over the past three months, rising 5% while the S&P 500 has risen 9%. They have also underperformed over the past 12 months, advancing 9% compared to a gain of 16% for the index. The beta on PAYX is 0.91.
On December 23, Paychex reported fiscal 2Q21 results that topped expectations. Adjusted net income rose 4% to $0.73 per share and topped the consensus estimate of $0.66. Service revenue was about flat at $968.9 million, and total revenue fell 1% to $983.7 million. Adjusted operating income rose 4% as the adjusted operating margin widened by 150 basis points to 36.0%.
For the first half, adjusted diluted EPS came to $1.36. A long with the fiscal 2Q results, management updated its FY21 guidance. It expects revenue to be flat to down 3% (compared to its earlier forecast of a 2%-4% decline), and looks for EPS to be down 1%-4% (compared to its prior call for a 6%-8% decline). It also projects an adjusted operating margin of 36%. It expects full-year revenue to be up 1% to down 1% (compared to prior guidance calling for a 1%-3% decline) in the Management Solutions segment, and a decline of 2%-5% in the PEO and Insurance Services segment.
EARNINGS & GROWTH ANALYSIS
The firm has three segments: Management Solutions (74% of sales), PEO and Insurance Services (24%), and Interest on Funds Held for Clients (1.5%). Second-quarter trends in these segments are summarized below.
In Management Solutions, revenue rose 1% to $732.8 million .Revenue in the PEO and Insurance Services segment fell 3%. Insurance Solutions revenue was impacted by a decrease in the number of health and benefit applicants and a decline in workers’ compensation premiums.
Paychex also generates interest revenue on the client funds it holds prior to pay dates.
Reflecting the better-than-expected fiscal 2Q results, we are raising our FY21 EPS estimate to $2.91 from $2.85. Our estimate is in line with management’s forecast range and implies an EPS decline of 3% this year. We look for growth to resume in FY22 and are maintaining our EPS estimate to $3.10
FINANCIAL STRENGTH & DIVIDEND
The company had cash and cash equivalents of $693.5 million. The total debt/capitalization ratio was 24%. The fiscal 2Q operating margin was 36%.
The company has a share buyback plan. The company did not repurchase any shares in the second quarter. As of November 30, 2020, it had $199.3 million remaining on its buyback authorization.
Paychex pays a dividend of $0.62 per share, or $2.48 annually, for a yield of about 2.7%. We think the dividend is sustainable. Our dividend estimates are $2.48 for FY21 and $2.64 for FY22.
MANAGEMENT & RISKS
Martin Mucci, 59, has served as president and CEO of Paychex since September 2010 and has been with the company since 2002, when he joined as SVP of Operations. Prior to Paychex, Mr. Mucci spent 20 years in the telecommunications industry with Frontier Telephone of Rochester. Efrain Rivera is the CFO. He joined Paychex in June 2011. B. Thomas Golisano is the company’s chairman.
Management’s strategy is to combine the company’s strengths in cloud-based services and customer service in order to drive growth in the client base, improve retention, and increase average revenue per client. It is targeting a long-term cash deployment strategy, consisting of stock repurchases, strategic acquisitions, and investments to drive organic growth. Investors in Paychex face numerous risks, including dependence on economic expansion and job growth to increase payroll service revenue. A downturn in the U.S. economy could trigger slower hiring and a reduction in the employee benefits handled by Paychex. In addition, the company could be hurt by lower interest rates, which would reduce interest and investment income.
COMPANY DESCRIPTION
Most of Paychex’s operations are domestic; however, the company does have four offices in Germany. The company serves approximately 680,000 payroll clients. Paychex is headquartered in Rochester, New York, and has about 15,600 employees.
VALUATION
We think that PAYX shares are attractively valued at recent prices near $93. Over the past 52 weeks, the shares have traded between $47 and $100 and are currently in the upper half of this range. On a technical basis, the shares had been in a long-term bullish pattern of higher highs and higher lows prior to the pandemic. They fell sharply in March, along with the market, but have risen strongly in recent months.
On December 31, BUY-rated PAYX closed at $93.18, up $1.04
Source: Argus
