ADP’s Results Provide Support For $61 Valuation

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ADP: Automatic Data Processing logo
ADP
Automatic Data Processing

Automatic Data Processing (NASDAQ:ADP) announced its Q1 FY13 earnings on November 1st, reporting organic revenue growth of 3% year-over-year to $2.6 billion. [1] While this is a substantial slowdown in year-over-year growth rates when compared to the previous quarter, we think that ADP’s results show that the sluggish world economy hasn’t hurt the company as much as we had feared. The company posted good growth in the average number of employees on its client payrolls, and posted encouraging 15% year-over-year growth in new business sales worldwide. In our opinion, this quarter’s growth numbers will contribute to keeping ADP’s fundamental valuation relatively stable going forward.

See our complete analysis of ADP here

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Core Business Sound

According to ADP’s management, the company reported results which were more or less in line with their expectations. For its Employer Services division, which is its core operating division and makes up approximately 76% of the company’s value,  ADP posted organic growth of 5%. Additionally, the company’s PEO and Dealer Services divisions also posted strong organic revenue growth of approximately 13% and 9%, respectively.

Growth in Client Employees Encouraging

We find it encouraging for ADP’s long term prospects that the number of employees on its client payrolls increased approximately 3.3% year-over-year. This is important since ADP’s clientèle increased the number of employees during a quarter plagued with uncertainties surrounding the US and world economy.

Since companies that hire during an uncertain economic environment are likely to be fundamentally sound, we think that any improvement in the world economy could see them hiring a bigger proportion of workers relative to the overall economy. If this occurs, we could see upside to the number of employees on client payrolls over our forecast period.

FY 2013 Outlook

ADP’s management does not expect the economic environment to change much over the next fiscal year. Since the company’s growth is correlated with employment growth in the country, management expects modest year-over-year revenue growth of around 5% in FY2013.

We agree with management in terms of muted growth during the fiscal year since we forecast only a 3% increase in the average employees per payroll account during 2013. However, due to some recent Chinese PMI data, we think that there could be potential upside to this metric. [2] If a sustained expansion in Chinese manufacturing occurs, it could buoy Chinese economic growth and also help the world economy overall. This scenario could lead us to see upsides to ADP’s revenues in FY2013.

Downside Is Small Due to QE3

During its October meeting, the Federal Reserve stuck to its QE3 plan which consists of buying securities until the labor market recovers materially. [3] We think that this policy could limit downside surprises to the US employment rate since US businesses know that the Federal Reserve will indefinitely inject liquidity into the market to ensure an economic recovery. Even if employment fails to rise as rapidly as the Fed hopes, limited downside to employment numbers makes ADP’s revenues a safer bet.

We currently have a $61 price estimate for ADP, which is approximately 5% above the current market price.

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Notes:
  1. Press Release, SEC []
  2. Twin China PMI surveys show economy perking up, Reuters []
  3. Fed sticks to QE3 plan, given mixed growth signals, Marketwatch []