ADP To Grow On Improving Job Environment But Low Interest Rates May Temper Revenues
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 its first quarter fiscal year 2015 (fiscal year ends Jun 30) on October 29 2014. We expect to see growth in ADP’s Payroll and HR services divisions driven by the improving job scenario. Though the quarter began on shaky grounds, with severe declines in quarter-on-quarter job additions, the September employment report renewed faith in the U.S. job environment. ADP’s client interest revenue will continue to remain a point of concern due to its consistent decline over the years driven by the low interest rate environment.
Revisiting the fourth quarter fiscal year 2014
Its fourth quarter revenue grew 8% year-on-year, to reach $3.07 billion, driven by 5% growth in new business bookings for its Employer and Professional Employer Organization (PEO) Services divisions. [1] However, declining interest earned from client funds partially tempered growth. For the full fiscal year 2014, ADP’s revenue grew 8%, in line with the company’s guidance.
The company’s net earnings for the quarter grew 27%, to reach $288.7 million, driving 30% growth in earnings per share. Full fiscal year 2014 earnings per share grew 9%. Along with the fiscal year 2014 results, ADP also shared its outlook for the fiscal year 2015, indicating high-single digit revenue growth. However, the growth includes the contribution of it’s soon to be spun off Dealer Services segment.
See our complete analysis of ADP here
ADP will likely have benefitted from job additions in the U.S.
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 job environment in the U.S. The number of job additions during the past few months has been subject to many revisions. The June 2014 job additions were reported as 288,000 in the employment summary issued by the Bureau of Labor Statistics (BLS) in July. However, this was revised to 298,000 in August and then to 267,000 in September. Inconsistent revisions indicate either a weak market or unreliable reporting, both of which are unfavorable for companies like ADP.
Though the July job additions were also revised, all subsequent revisions were higher than the previous one. Initially, job additions were reported to be 209,000 but the latest reports put it at 243,000. However, the main concern was the quarter-on-quarter decline which indicated a weakening job market. The only solace was the year-on-year positive growth. The biggest hit came with the initial reports for job additions for the month of August, which stood at 142,000, compared to the expectations of 225,000 additions. The disappointing August job additions had a negative impact on ADP’s stock price, which declined 1.57% during the week ending September 12, when the report was released.
However, the stronger than anticipated September employment report, released on October 3, instilled a positive outlook overall. The unemployment ratio declined to 5.9%, lowest in the past 6 years, with 248,000 job additions, which exceeded economist’s expectations of 215,000 additions. [2] The job additions for the month of August, earlier reported to be 142,000, were also revised to 180,000, a far more comfortable level considering that the twelve month average stood at 214,000 at the end of July. The positive year-on-year job addition bodes well for ADP’s employees per client metric. However, considering the sluggishness in the U.S. job environment, the growth in employees per client may not be as strong as the previous quarter, wherein employees per client grew 2.8%.
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 September 30 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]
We expect the low interest rate scenario to continue in the short term and present headwinds for ADP’s interest earned on funds held for clients. However, once the Quantitative Easing program in the U.S. comes to an end in October, the Fed may begin to increase rates in mid-2015. [5] This may help drive growth in ADP’s interest earned on funds held for clients.
For the fiscal year 2015, ADP expects its interest on funds held for clients increase $5-$15 million based on an anticipated growth in average client funds balances of approximately 5-7%. However, this may be partially offset by decline of up to 10 basis points in the expected average interest yield to 1.7-1.8%.
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- ADP Reports Fiscal 2014 Results, July 31 2014, www.adp.com [↩]
- Employment Situation Summary, October 3, 2014, www.bls.gov [↩]
- US Generic Govt 10 Year Yield, www.bloomberg.com [↩]
- US Generic Govt 5 Year Yield, www.bloomberg.com [↩]
- Two Fed officials say interest rates to rise in mid-2015, October 9, 2014, www.fortune.com [↩]