Paychex: HR Outsourcing Division In Focus

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PAYX: Paychex logo
PAYX
Paychex

Paychex (NASDAQ:PAYX) offers payroll processing to businesses of varying sizes around the globe. Payroll processing includes the paper and electronic distribution of employee compensation, along with the processing of tax withholdings and other employee contributions. Businesses save time and resources by outsourcing their payroll processing needs to companies like Paychex.

The two biggest contributing divisions to Paychex’ stock price are Payroll Processing and HR Outsourcing. In this article, we discuss Paychex’ second most valuable division- HR Outsourcing, and analyze how this business segment impacts the company’s valuation.

We have a price estimate of ~$35 for Paychex, which represents a downside of ~16% to the market price.

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Paychex offers the following services under its broad business segment of HR Services:

HR Outsourcing

Human Resources Outsourcing is the second largest business segment for Paychex contributing ~32% to the company’s valuation. Paychex offers the following services

1) HR Outsourcing: This is primarily classified under Paychex Premier and Professional Employer Organization(PEO). The difference between the two is that with PEO, the client maintains control over its employees and daily operations, while Paychex helps manage its employee benefits and payroll. [1]These services offer comprehensive packages of payroll, compliance, employee benefits administration, 401K retirement savings plan management and onsite trained HR representatives.

2) Retirement Services: Offer various plans which allow employers to choose how their retirements funds will be managed in terms of investments.

3) Insurance Services: Plans to cover employees who need to be paid while on leave due to job-related injuries.

4) Others Services: These include health and benefits services, time and attendance solutions, and others, such as employee manuals and management handbooks.

Future Trends

Paychex’ clients are primarily small and medium-sized businesses. These clients usually have less than 50 employees and want comprehensive outsourcing services such as retirement plan management, insurance and health benefit management. Clients are also extremely sensitive to the price at which these services are being offered. However, as the complexity of the services being offered increases, Paychex tends to gain more bargaining power over its clients as it becomes harder to switch. Moreover, small businesses don’t have a strong foothold in the market and consequently can’t dictate terms with their service providers, especially with market leaders such as Paychex.

Revenue per Employee Served by Paychex HR Outsourcing has been quite volatile over the years, remaining between a range of $900 and $1,000. However, Paychex has been able to maintain price increases over the years, mostly by up-selling to existing clients. These clients take up complementary services over time in order to make their employee business more streamlined and efficient. We expect the fee per employee for Paychex to increase from $1,000 in 2013 to $1,250 by the end of our forecast period.

HR Outsourcing EBITDA Profit Margin has decreased marginally from ~43% in 2009 to ~42% in 2013. We expect it to decline over the period and touch ~39% by the end of our forecast period. [2]This prediction of the decline in margin is based on the following factors:

1) Larger competitors such as Automatic Data Processing (NASDAQ:ADP) have been expanding into the small-businesses market. [3] Paychex might have to start charging lower prices in order to maintain its client base in the face of this rising competition.

2) Paychex is also prone to competition from online payroll processing companies such as Intuit, further impacting the company’s margins negatively.

Overall, we think that the growth in this division is good news for Paychex as it diversifies the company’s operations. Providing services such as retirement and insurance outsourcing gives Paychex a product line which it can sell to its existing customers, who currently use only the payroll services. We will be watching this division closely over the coming quarters, as it will be key to Paychex’ growth.

Notes:
  1. Paychex PEO Services []
  2. PAYX SEC Filings []
  3. ADP Small Business Solutions []