The Bank of England cut its growth forecasts for the U.K. for 2012 Wednesday, a further evidence that the global economy is not recovering as quickly as expected.  The bank’s head, Mervyn King, also provided weak forecasts for the coming years and stated that he does not expect economic activity to rise to the pre-recession peak levels until 2014. These forecasts, along with Ben Bernanke’s sober outlook for the U.S. economy, signals that employment growth will probably slow down as the current Eurozone crisis will put downward pressure on demand.  We think that a possible slowdown in the economy could have a negative impact on the valuations of payroll processors such as Paychex (NASDAQ: PAYX) which rely on employment and business growth for their revenues.
According to our estimates, payroll processing represents 73% of Paychex’s total value. Two of the primary drivers within this segment, average employees per payroll client and number of payroll clients, are correlated with overall economic activity. For example, if economic growth slows and business confidence falls, employers will be expected to either stop hiring and wait for better conditions, or trim their payrolls if their businesses are struggling. Either of these scenarios will have a downside impact on the two drivers above and consequently Paychex’s value.
We currently estimate that the average number of employees per payroll client will grow to approximately 19 by the end of our forecast period. However, if the slowdown in the global economy manifests and the figure drops to 18, there could be a 5% downside to the Trefis price estimate. You can assess the impact that the increase in the average number of employees per payroll client will have on our price estimate by using the chart below.
Overall, as Ben Bernanke stated, the global economic situation is expected to remain uncertain until the Eurozone and the U.S. fiscal situations are resolved. Since a time frame for these solutions have not yet been established, the macro-economic uncertainty is expected to stem hiring growth, and this is likely to negatively impact Paychex’s value.
We currently have a $33 price estimate for Paychex, which is in-line with the current market price.Notes: