Near-Term Decline in ADP’s Payroll Revenues From Small Businesses Expected

ADP (NASDAQ:ADP), a leading payroll processor along with Paychex (NASDAQ:PAYX), serves many large businesses in the US and also caters to a sizeable number of small businesses (fewer than 50 employees).  ADP served a total of 425,000 small business clients in 2008 before the economic crisis began. This number decreased by more than 10,000 in 2009, and we expect this declining trend to continue for the next few years.

We estimate that payroll processing constitutes 83% of the $52 Trefis price estimate for ADP’s stock. Small businesses are still struggling to survive in the weak macroeconomic environment, and some are closing down or laying off employees.

The results of a recent survey by National Federation of Independent Business (NFIB) suggest that more jobs will be eliminated by small business owners in the near future.  A decline in the number of ADP small business customers along with a decline in the average number of employees at small businesses will negatively impact the payroll processing revenues that ADP earns from these businesses.

Decline In Number of Small Businesses To Continue

Small businesses are very vulnerable during an economic recession and run a high risk of bankruptcy. Sustaining profitability becomes difficult owing to weak sales with less demand for payroll services.  Payroll processors like ADP and Paychex are finding it tough to get new accounts with new originations being at historic lows and closure rates at historic highs in the past two years.

ADP’s client base of small businesses declined from 425K in 2008 to 414K in 2009. We expect the number to decline further to 400K by the end of 2010.

Average Number of Employees Per Small Business To Decline

According to a March 2010 survey by Discover Small Business Watch, around 53% of small business owners expect their businesses to deteriorate further in the next six months. The hiring conditions look grim with an unemployment rate of around 9.5%.

We believe job creation in this segment will be at a lower rate than job losses, resulting in a decline in the average number of employees of small businesses.  We expect the average number of employees per ADP’s small business clients to decline to 9 in 2010.

With shrinking client base coupled with declining average number of employees, we expect ADP’s payroll service revenues from small businesses for 2010 to slide downward by around 4% compared to 2009.

You can see our complete analysis for ADP’s stock here.