ADP Earnings: Payroll Processing Strong But Client Funds Interest Still Sluggish

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ADP: Automatic Data Processing logo
ADP
Automatic Data Processing

Automatic Data Processing (NASDAQ:ADP), the largest payroll processing and human capital management solutions provider in the U.S., released its earnings results for the second quarter of fiscal year 2014 on Wednesday, February 5. All of the company’s business segments delivered strong revenue growth. [1] Payroll Processing, the company’s biggest division, posted 9% year-over-year growth while the Dealer Services division also demonstrated strength with revenues rising by 7%. ADP’s total revenue increased 9% y-o-y to $3 billion, despite lower returns on the high margin client interests revenue. Net earnings grew by 7% y-o-y due to a lower effective tax rate.

Our current price estimate of $73 for ADP stands almost level with the market price.

See our complete analysis of ADP here

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Healthy Employment Scenario Supports Payroll Processing

Employer Services and PEO Services are ADP’s major businesses in payroll processing. Employer Services revenue increased 9% y-o-y in Q2 FY 2014 , while PEO Services revenue grew by 14% y-o-y. Both of these businesses are extremely sensitive to U.S. job market conditions. The job market has picked up in the last few months across all segments of the U.S. economy, including small, medium and large businesses. Additionally, ADP’s newest cloud platforms – ADP RUN® for small businesses, and ADP Workforce Now® for mid-sized businesses – showed strong growth, with 360,000 clients now on the user list. [2]

According to ADP’s monthly national employment report, over 200,000 jobs were added in the small business segment (1-49 employees) in November and December; the medium business segment (50-499 employees) and the large business segment (>500 employees) added more than 100,000 jobs each in the two months combined. Overall, the job market seems to be improving and is likely to benefit ADP in the form of a greater number of client employees. This was the case in the second fiscal quarter, with client employees up 2.9% y-o-y. [3]

Falling Client Interest Revenue Still A Drag

The interest on funds held for clients fell by more than 12% y-o-y during the quarter to $12.5 million. The company’s management attributed this slowdown in client funds interest to a decline of about 50 basis points in the average interest yield to 1.9%. This drop was partially offset by an increase of 9% in average client funds balances from $17.0 billion to $18.5 billion.

A consistent decline in interest earned on client funds in recent years has been the most significant drag on ADP’s earnings. The company earned $684 million as interest on client funds in FY2008, which declined to $421 million in FY 2013, even though average client fund balances increased from $15.5 billion to $19.2 billion during the same period. This was the result of the low interest rate environment in the U.S.

ADP sees the decline in interest earned on client funds to be bottoming out in terms of the size of the year-on-year decline, thanks to rising yields on U.S. Treasuries. The company estimates a total pre-tax impact of $50-$60 million in FY 2014 due to lower interest, which is less than the $88 million in FY 2013. Almost half of this is expected to occur in the first quarter, with a reduced negative impact as the company progresses through the year. [4]

Revised Outlook for 2014

Following these results, ADP has revised its outlook for fiscal 2014. The management expects revenues to grow between 7%-8%, compared to the previous guidance of 7%. Employer services are expected to grow by 7%, consistent with the previous forecast, while PEO services are expected to grow around 2% higher than the previous forecast of 10-12% growth. Interest on funds held for clients is expected to decline $40 to $50 million, or 10% to 12%, based on a decline of 30 to 40 basis points in the expected average interest yield to 1.8% to 1.9%. This should, however, be partially offset by anticipated growth in average client funds balances of approximately 6% to 7%, an increase from the prior forecast of approximately 5%. [1]

We are in the process of updating our $73 price estimate for ADP based on the recent quarterly results.

Notes:
  1. ADP 8K Investor Relations [] []
  2. ADP Q2 FY14 Earnings Call Transcript []
  3. ADP employment report []
  4. ADP Q4 FY13 Earnings Call []