Paychex Earnings Preview: Health Insurance Demand, Job Environment To Drive Results

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Paychex (NASDAQ:PAYX) is scheduled to announce its fiscal first quarter earnings on Wednesday, September 30, before the market opens. [1] The company had a strong end to its fiscal 2015 which ended in May, with its Human Resource Services (HRS) segment driving much of the top line growth. the HRS segment is likely to continue to boost top line figures owing to a new health insurance offering, which contributed 6 percentage points to the revenue growth in the most recent quarter. Meanwhile, the company’s Payroll segment has witnessed steady growth in the number of clients and realized revenue per client over the last few quarters. [2]

Earlier this month, Paychex’s management indicated that the company is expecting consistent growth opportunities for small businesses to continue, and expects greater employment growth in the small business market. The Paychex IHS Small Business Jobs Index (SBJI) will have a more detailed report on small business employment opportunities and will include a more detailed analysis of hiring trends across the U.S. starting September 29. [3]

We currently have a $48 price estimate for Paychex’s stock, which is in line with the current market price.

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See our complete analysis of Paychex here

Health Insurance Demand Can Sustain HRS Growth

Rising demand for healthcare products led to an 18% annual growth in HRS segment revenues in fiscal 2015. One of the primary reasons for growth in the new health insurance product is the Patient Protection and Affordable Care Act (PPACA), which has driven over 17 million enrollments on the Health Insurance Marketplace since November last year. [4] However, many employers remain largely unprepared to comply with the PPACA, giving Paychex and competitors scope for growth. According to recent research by rival ADP (NASDAQ:ADP), many large employers (1,000+ employees) in the U.S. are unprepared to comply with the regulations of the PPACA. [5] As businesses continue to buy health insurance for their employees to remain compliant with the PPACA, we believe that Paychex’s new insurance offering will continue to grow.

Another key area where Paychex witnessed solid growth numbers was its retirement services. The number of retirement services clients jumped by almost 8% through fiscal 2015 to 70,000 clients. The company benefited from its pricing structure, an increase in asset value and growth in the number of plans. Similarly, the number of HR outsourcing clients served increased from 28,000 in FY’14 to 31,000 through FY 2015 – an 11% annual rise. With a sustained growth in numbers expected in this segment through the coming quarters, Paychex expects a 10-13% growth in revenues from combined human resource services through fiscal 2016.

 

Pricing, Client Base To Drive Payroll Revenue

Paychex’s prime market includes small businesses, typically with less than 50 employees. While the broader job market remained strong over the last few quarters, the small business index reflected flattish growth in Q4’15 and Q1’16. The Paychex IHS Small Business Jobs Index, which analyzes changes in small business employment trends, declined by 0.17% sequentially in the month of August, following several months of little or no movement in employment growth. Despite the slight dip in August, Paychex CEO Marty Mucci remained hopeful about future growth in small business. [6] Moreover, things could get tough even tougher for Paychex and ADP in the coming quarters due to increased competition from new entrants in the payroll outsourcing market. Players like Zenefits and Namely have been gaining a lot of popularity due to their HR software platforms and have investments pouring in. These companies are particularly targeting small businesses, making them a larger concern for Paychex.

According to the Employment Situation Summary released by the U.S. Bureau of Labor Statistics (BLS), the unemployment rate in the U.S. decreased from 5.4-5.5% April and May to 5.1% in August. [7] The decrease was driven by job gains in health care and social assistance and financial activities due to which the total non-farm payroll employment increased by 173,000 through August. Similarly, the unemployment rate and the number of unemployed persons were down by a percentage point and 1.5 million, respectively, since the beginning of the year. This indicates continued momentum in the U.S. job market.

We believe that Paychex is likely to see continued growth in its client base since companies are increasingly looking to outsource their payroll. Outsourcing allows these companies to focus on their core businesses and also generally benefit from reduced operating costs. Additionally, companies such as Paychex are better equipped to deal with the complexities of various regulations. This trend is expected to help the global HR Outsourcing industry grow at an average rate of 12.3% through 2018. [8]

Margins And Outlook For FY 2016

Paychex reported 9% year-on-year growth in net revenue for FY 2015 to $2.7 billion, driven by strong growth in its HRS segment. HRS revenues crossed the $1 billion mark for the first time in its history, while Payroll revenues were up by 4% y-o-y to $1.7 billion. However, the company’s operating expenses were up by 10% for the fiscal year, mainly due to higher compensation-related costs. As a result, the company-wide EBITDA margin compressed through fiscal 2015. According to our estimates, Paychex’s adjusted EBITDA margin was about 70 basis points lower than the previous year at 42.6%.

The company expects its FY’16 revenues to grow at a similar rate through the year. Payroll revenues could be about 4-5% higher than previous year levels, while HRS revenues are likely to sustain a double-digit growth rate. With growth in revenues and a relatively lower increase in operating expenses, the company expects operating margin to improve by about 2-3 percentage points through the coming year. However, with small business job growth following an inconsistent pattern, it is likely that Paychex may soon begin to feel the heat. Moreover, Paychex could have a tougher time competing with Zenefits and Namely in the coming quarters, though its pricing increases and steady growth in client base could help drive its top line.

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Notes:
  1. Paychex Schedules First Quarter Fiscal 2016 Earnings Release Conference Call For Sep 30, Paychex Press Release, September 2015 []
  2. Paychex Q4 2015 Earnings Call Transcript, Seeking Alpha, July 2015 []
  3. Paychex|IHS Small Business Jobs Index to Deliver New Data and Analysis on Small Business Employment Growth, Market Watch, September 2015 []
  4. 17.6 million have gained insurance through PPACA, Benefits Pro, September 2015 []
  5. One in Two Large Employers Unprepared to Fully Comply with the Affordable Care Act, ADP Press Release, January 2014 []
  6. Small business is back: Paychex CEO, Yahoo! Finance, September 2015 []
  7. Employment Situation Summary, Bureau of Labor Statistics, September 2015 []
  8. Global Human Resource Outsourcing Market 2014-2018, August 18, 2014, www.prnewswire.com []