Paychex (NASDAQ:PAYX) caught my eye today, as it recently reported its earnings and the stock is moderately selling off. This company is a high-yielding, moderate-growth company that I think can fill a unique niche in the financial section of your portfolio. For those who do not know this company, it provides provides payroll, human resource, insurance, and benefits outsourcing solutions for small to medium-sized businesses in the United States and Germany.
The company offers payroll processing services that include the calculation, preparation, and delivery of employee payroll checks; production of internal accounting records and management reports; preparation of federal, state, and local payroll tax returns; and collection and remittance of client’s payroll obligations. It also provides a suite of self-service online payroll services and products, including Paychex Online Payroll, Internet time sheets, online reports, and general ledger reporting service. It offers payroll tax administration services, employee payment services, and regulatory compliance services, such as new-hire reporting and garnishment processing.
Further, it provides retirement services administration; insurance agency services for property and casualty; business owner, commercial auto, and health and benefits insurance products; as well as online human resource administration software tools for managing employee benefits, personnel information, and human resource compliance and reporting.
The company’s main competitors are Automatic Data Processing (NASDAQ:ADP) and TriNet Services (NYSE:TNET). However, these competitors trade at a premium multiple relative to Paychex. Paychex trades at 24 times earnings, whereas Automatic Data Processing trades at 27 times earnings and TriNet trades at a whopping 156 times earnings. Further, although Automatic Data Processing and TriNet are competitors, they don’t exactly serve the same clients. TriNet provides human resources solutions to small- and medium-sized businesses in the United States and Canada, but not Germany.
TriNet offers services like payroll processing, human capital consulting, and employment law compliance, as well as employee benefits including health insurance, retirement plans, and workers compensation insurance. It serves technology, life sciences, property management, professional services, banking and financial services, retail, manufacturing, and hospitality markets, as well as non-profit entities. Automatic Data Processing is a bit more specialized, although it serves many employers. But Paychex is my preferred play in this space.
In its most recent quarter, Paychex saw total service revenue increase 6 percent for both the fourth quarter and fiscal year, compared to the respective periods last year. Net income and diluted earnings per share both increased 18 percent for the fourth quarter and 10 percent for the fiscal year, compared to the respective periods last year. Payroll service revenue increased 3 percent for the fourth quarter and 4 percent for the fiscal year, compared to the respective periods last year. So what is behind the rise?
Well, these increases were driven by growth in revenue per check, client base, and checks per payroll. Revenue per check improved as a result of price increases, partially offset by discounting, coupled with the impact of increased product penetration. At the end of the quarter, Paychex served approximately 580,000 payroll clients, an increase of approximately 2 percent from last year. Checks per payroll increased 1.1 percent for the fourth quarter, but real growth was seen in human resources.
Human resources revenue increased 10 percent for the fourth quarter and 12 percent for the fiscal year, compared to the respective periods last year. The growth in human resources revenue was driven primarily by client base growth, particularly in Paychex HR Solutions, retirement services, and online HR administration products. Paychex HR Solutions was the largest contributor to this growth, experiencing increases of 13 percent in clients and 14 percent in client employees served year over year. Retirement services revenue was positively impacted by a 5 percent increase in plans as of May 31, 2014, compared to May 31, 2013, and it also benefited from a 13 percent increase in the average asset value of participants’ funds.
Finally, operating income increased 8 percent for the fourth quarter and 9 percent for the fiscal year compared to the respective periods last year. Operating income and the net of certain items also increased 8 percent for the fourth quarter and 9 percent for the fiscal year, compared to the respective periods last year.
This stock trades at a slight market premium, but it deserves it. Its financial position as of May 31 remained strong, with cash and total corporate investments of $936.8 million and no debt. It does not borrow to get cash — rather, the company’s primary source of cash is generated from its ongoing operations. The company successfully funds its operations, capital purchases, business acquisitions, share repurchases, and dividend payments from its operating activities.
Paychex’s positive cash flows have allowed it to support its business and to pay substantial dividends to its stockholders. Looking ahead, the company’s expected full-year fiscal guidance sees payroll revenues coming in with gains of 3 to 5 percent, human resources gaining 16 to 10 percent, total service revenue rising 8 to 10 percent, and net income as a whole rising 6 to 8 percent compared to last year. All things considered, I rate this stock a great buy.
Disclosure: Christopher F. Davis holds no position in Paychex and has no intention of initiating a position in the next 72 hours. He has a buy rating on the stock and a $45 price target.