Paychex Corporation (NASDAQ:PAYX) is one of the two major publicly traded payroll processors in the United States. The company generates revenues by processing employee payrolls which includes paper and electronic distribution of employee compensation along with the processing of tax withholdings and other employee contributions. The company primarily competes with much bigger ADP (NASDAQ:ADP), which has a market capitalization of approximately $30 billion compared with Paychex’s market capitalization of $12 billion.
Paychex generated approximately $2 billion in revenues and had EBITDA margins of approximately 42% in 2012, and we think that both of these metrics will rise over our forecast period. The company has two primary divisions, payroll processing, which makes up 60% of the firm’s value, and HR outsourcing, which make up over 30% of value.
Payroll Processing Tied With Employment Growth
As mentioned above, Paychex’s payroll processing division makes up approximately 60% of the firm’s value. The primary driver of this division is the number of employees per client payrolls, as the company gets paid on a per employee basis.
We estimate that in FY 2012 the company was processing approximately 9.5 million employee payrolls, as it had 567,000 clients with an average of 17 employees per client. We think that both the average client employees and number of clients will increase over our forecast period to approximately around 19 and 620,000 respectively. The primary rationale for both of these forecasts is that we expect the global economy to improve in the next couple of years which should spur hiring growth and new business creation. In a scenario where the global economic environment in 2-3 years time worsened and the average employees per payroll client fell to 16 by the end of our forecast period, we would see approximately 10% downside to our price estimate.
HR Outsourcing is The Primary Growth Driver
While Paychex’s payroll division has been a relatively stable revenue source of revenues over the past couple of years, the company’s HR outsourcing division has been the primary contributor of growth. The division’s revenue increased 13% in FY 2012, primarily due to price increases and growth in both clients and client employees.
As with the firm’s payroll processing division, Paychex’s HR outsourcing division is also dependent on the number of employee’s the company serves. In FY 2012, the firm had approximately 615,000 client employees, and we expect this number to grow to approximately 800,000 by the end of our forecast period. The major driver of this growth will likely be the result of Paychex up-selling to existing clients and also a potential economic recovery in the United States, which will increase the number of employees at their existing clients. For sensitivity purposes, if the number of HR outsourcing client employees served stayed flat over our forecast period, we would see approximately 5% downside to our price estimate.
We currently have a $35 price estimate for Paychex, which is approximately 10% above the current market price.