ADP’s Earnings Will Benefit From Upswing In Second Quarter Hiring In The U.S.
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 fourth fiscal quarter (fiscal year ends Jun 30) on July 31 2014. In the previous quarter, its revenue grew 7% year-over-year, to reach $3.3 billion, driven by 14% growth in new business bookings for its Employer and PEO services. [1] The company’s net earnings grew 7% to reach $510.4 million. During the third quarter meet, ADP revised its revenue guidance from 7-8% to 8% for fiscal 2014.
For the fourth fiscal quarter, we expect to see growth in ADP’s payroll business driven by the strong growth in job additions across all sectors in the U.S. in the quarter ending June 31 2014.
We currently have a price estimate of $64 for ADP, ~22% less than the current market price.
See our complete analysis of ADP here
Strong 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 the U.S. Bureau of Labor Statistics, around 816,000 jobs were added in the non-farm private sector in the quarter ending June 31 2014, around 213,000 jobs more than what was added in the quarter ending June 31 2013. [2] Growth in the number of jobs added was broad based. From goods-producing industries such as manufacturing and construction, to service-providing industries such as retail, health care, transportation and financial, all saw growth during the quarter. Broad-based growth accompanied with consistent 200,000+ additions of jobs every month since the past five months is a good signal that the job environment in the U.S. will continue to remain strong in the coming quarters.
Overall, the job market seems to be growing at a strong pace and is likely to benefit ADP in the form of a greater number of client employees. This was the case in the third fiscal quarter, with client employees up 2.8% year-over-year.
Employer and PEO Services revenue increased 6% and 15% year-over-year in the third 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, driven by 2%-3% growth in pays per control metric. Additionally, PEO services are expected to grow around 14%, compared to the previous forecast of 12%-13% growth. [1]
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. In the quarter ending June 31 2014, both ten years and five years U.S treasury securities yields declined at the beginning of the quarter with some recovery towards the end. [3] [4]
Interest on funds held for clients is expected to decline $45 to $50 million based on a decline of 40 basis points in the expected average interest yield to 1.8%. This should, however, be partially offset by anticipated growth in average client funds balances of approximately 8%, an increase from the prior forecast of approximately 6%-7%.
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Notes:- ADP Reports Third Quarter Fiscal 2014 Results, April 30 2014, www.adp.com [↩] [↩]
- Employment Situation Summary, www.bls.gov [↩]
- US Generic Govt 10 Year Yield, www.bloomberg.com [↩]
- US Generic Govt 5 Year Yield, www.bloomberg.com [↩]