Improving Employment Scenario Will Help Drive ADP’s Earnings
Automatic Data Processing (NASDAQ:ADP), the largest provider of payroll processing and human capital management solutions in the U.S., is set to release its results for the third fiscal quarter (fiscal year ends Jun 30) on April 30 2014. In the previous quarter, ADP’s Payroll Processing division and Dealer Services division posted a 9% and 7% year-over-year growth respectively. ADP’s total revenue increased 9% year-over-year to $3 billion, despite lower returns on the high margin client interest revenue. Net earnings grew by 7% year-over-year due to a lower effective tax rate. Given the strong growth rates achieved during the second quarter, ADP revised its guidance for the year 2014. The company now expects revenues to grow between 7%-8%, compared to the previous guidance of 7%.
For the third fiscal quarter, we expect to see growth in ADP’s payroll business driven by the increasing job opportunities available in the U.S. However, declining yields may continue to temper growth in interest earned on client funds. [1]
We currently have a price estimate of $73 for ADP, ~4% less than the current market price.
See our complete analysis of ADP here
Improving Employment Scenario Bodes Well For ADP’s Payroll Processing Business
Employer Services and PEO Services are ADP’s major businesses in payroll processing, which together generate close to 90% of the overall revenues. These businesses are highly dependent on the employment rate in the U.S. economy. According to ADP’s monthly national employment report, over 500,000 jobs were added in the private sector in the quarter ending March 31 2014. Out of this, 200,000 were added in the small business segment (1-49 employees); 153,000 were added in the medium business segment (50-499 employees) and 145,000 were added in the large business segment (>500 employees). 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% year-over-year. [2]
Employer and PEO Services revenue increased 9% and 14% year-over-year in the second fiscal quarter of 2014. Given the improvement in the employment situation in the U.S., ADP’s employer services are expected to grow 7% in 2014, consistent with the previous guidance. However, PEO services are expected to grow 12%-13%, compared to the previous guidance of 10-12% growth. [3]
Client Interest Revenue Will Continue To Be A Drag On Earnings
The interest earned on client funds is a significant contributor to our estimate of ADP’s stock value and accounts for 20-25% of the company’s operating income. ADP invests client funds in U.S. Treasury securities and takes a small percentage of the interest earned as commission. Change in yields of the U.S. securities and average client funds held by ADP significantly impact its earnings.
For the past few years, low interest rates in the U.S. have led to consistent declines in ADP’s interest earned on client funds. The company earned $684 million as interest on client funds in FY2008, which declined to $421 million in FY 2013, even as average client fund balances increased from $15.5 billion to $19.2 billion over the same period. In the second fiscal quarter, interest on funds held for clients fell by more than 12% year-over-year to $12.5 million due to a decline of about 50 basis points in the average interest yield to 1.9%. However, the drop in interest earned was partially offset by 9% increase in average client funds balances from $17.0 billion to $18.5 billion.
Interest on funds held for clients is expected to decline $40 to $50 million during FY 2014, 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%. [3]
We will update our $73 price estimate for ADP once the company files its quarterly results.
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Notes:
- US Generic Govt 10 Year Yield, www.bloomberg.com [↩]
- ADP National Employment Reports, www.adpemploymentreport.com [↩]
- Q2 2014 Automatic Data Processing Earnings Conference Call Presentation, February 5 2014, www.adp.com [↩] [↩]