ADP Rides A Stronger Job Market But Low Interest Rates Are Still A Pain
Automatic Data Processing (NASDAQ:ADP), the largest payroll processing and human capital management solutions provider in the U.S, declared its Q4 and FY 2013 results on August 1. In line with the company’s guidance, the yearly revenue grew 7% to $11.31 billion as compared to $10.7 billion in FY 2012. ADP’s main business division, Employer Services, posted a 7% growth for the year with the pre-tax margin expanding 120 basis points for the quarter and 60 basis points for the year.
However, ADP’s overall pre-tax margin was negatively impacted by 110 basis points primarily on account of lower interest earned on client’s funds even while the business segments achieved strong margin expansion. Another major contributor to the operating income interest earned on client’s funds-declined 15% from $493.3 million in FY 2012 to $ 420.9 million in FY 2013, due to a 60 basis points reduction in the average interest yield which fell to 2.2%. Overall the results were in line with expectations as all the business segments performed well, however, interest on client’s funds continued to be a dampener. [1]
This year’s reported earnings include a $43 million pre-tax non-cash goodwill impairment charge and a $66 million pre-tax gain on sale of assets. The company also released an adjusted measure of its earnings to present a true picture of its operational performance that is devoid of the items mentioned above. On an adjusted basis, ADP’s FY 2013 pre-tax earnings from continuing operations increased 4% to $2.13 billion while the reported pre-tax earnings declined 1% to $2.08 billion. ADP also gave its FY 2014 guidance of 7% revenue growth with a slight improvement in the adjusted 18.8% FY 2013 pre-tax margin. [1]
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Employer Services: Resurgent Labor Market Helps Deliver Strong Results
Just a day before the results, ADP released its monthly employment report which showed signs of the job market becoming buoyant once again. ADP’s National Employment Report said that the U.S. economy added 200,000 private sector jobs in July, as compared to 198,000 jobs in June with June’s figure being revised higher from 188,000 previously. (see ADP Earnings Preview: U.S. Jobs And Higher Interest Rates In Focus) The small business segment (1-49 employees) saw major job growth which added 82,000 jobs in July. The medium (50-499 employees) and large (more than 500 employees) business segments also showed upbeat hiring interest by adding 60,000 and 57,000 jobs respectively. [2]
Strength in the labor market has certainly trickled down to ADP’s core business and helped it achieve its target of 7% growth for the Employer Services division. ADP’s strong business acumen and client relationships also came to the fore as client retention reached a new high of 91.3%, improving by 0.4 percentage points over the fiscal year. Also, a 2.8% yearly growth in the number of employees for ADP’s clients confirmed the uptake in the job market. With better employment prospects in the U.S economy, we believe that ADP will continue to benefit from a higher number of employees per client. As far as margins are concerned, ADP’s focus on improving its operational efficiency has yielded splendid results. Pre-tax margins for all business segments have shown marked improvement over the previous year. More specifically, pre-tax margins for Employer Services, PEO Services & Dealer Services have improved by 60, 50 and 180 basis points, and now stand at 27%, 10.1% 18.5% respectively. Furthermore, the company has guided for margin expansion in all its business segments for FY 2014. [1]
Interest On Client’s Funds Continues To Drop
ADP’s business model has made it one of the most stable and best performing stocks in the U.S. However, there is one thing that has been limiting ADP’s value and that is the interest earned on client’s funds. With low interest rates prevailing in the U.S and much of the developed economies, the interest income on client’s fund investments has been consistently declining from 2008 onwards despite increase in the investment balances (client’s funds). The $684 million as interest on client’s funds in FY2008 has declined to $ 421 million in FY 2013, even as average client’s funds balances have increased from $15.5 billion to $19.2 billion over the same period. For the fiscal year ending June 30, 2013, average client’s funds grew 7%, partially offsetting the impact of lower interest yield.
However, if the interest rates were to increase going forward, ADP would be able to achieve better results. Things have started moving in that direction with the Federal Reserve Bank’s announcement that it plans to gradually taper off its QE bond buying program if the U.S. economy strengthens. This has caused the yields on 10 year U.S Treasury bonds to rise to 2.74% from 2.2% two months ago. The sudden reversal in yields bodes well for ADP, but the trend would need to continue to have a meaningful impact on ADP’s financial performance. [3]
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Notes:- ADP FY2013 Results, ADP [↩] [↩] [↩]
- ADP July National Employment Report, ADP [↩]
- US Treasury Bond Yields, US Department Of Treasury [↩]