Paychex Earnings: Health Insurance, Payroll Drive Q2’16 Results

Paychex (NASDAQ:PAYX) announced its fiscal second quarter earnings on December 22, reporting a 7% annual rise in net revenues to $722 million for the quarter. ^[1] In line with the company’s expectations, its payroll service revenue was up by about 4% on a y-o-y basis to $427 million – a trend consistent over the last few quarters. On the other hand, Paychex’s human resource services (HRS) division continued its double digit growth spree with revenues rising by 11% y-o-y to $284 million for the quarter. HRS revenues have sustained growth this year due to the company increasingly outsourcing its HR solutions to its clients. ^[2]

We currently have a $48 price estimate for Paychex’s stock, which is slightly lower than the current market price. Paychex’s stock price has fluctuated between $43 and $54 in the current fiscal year.

See our complete analysis of Paychex here

 Payroll Revenues Sustain Growth

Paychex has witnessed 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. Additionally, Paychex has observed a consistent 2-4% price increase over the last few quarters to complement the growth in its customer base. ^[2] As a result, payroll revenues have risen by a consistent 4% y-o-y in both Q2 and the six-month period ended November to $427 million and $860 million, respectively.

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 the last few quarters. Earlier this month, Paychex reported November figures in the Paychex IHS Small Business Jobs Index (SBJI). The national index, which analyzes changes in small business employment trends, for November stood at 100.42, which implies that the pace of employment growth is was 0.42% faster than growth in the base period about ten years ago. However, the index was 0.31% lower on a year-over-year basis – a trend consistent over the last few months. Back in September, the company’s management indicated that Paychex could witness consistent growth opportunities for small businesses to continue, and expects greater employment growth in the small business market. ^[3]

Health Insurance Demand Can Sustain HRS Growth

The company’s solid start to fiscal 2016 has been largely driven by the company’s Human Resource Services (HRS) segment revenues, which have risen by 13% year-over-year to nearly $564 million. A key reason for the growth in HRS revenue was the Patient Protection and Affordable Care Act (PPACA), which includes a regulation wherein many employers are required to provide health insurance to employees. According to research conducted by Automatic Data Processing (NASDAQ:ADP) earlier in the year, around half of the large employers (1,000+ employees) in the U.S. were unprepared to comply with the regulations of the PPACA. ^[4]

Paychex’s new health insurance offering contributed 6 percentage points to the revenue growth in the fiscal first quarter. The trend continued in the second quarter, with Paychex’s ESR products aiding clients with healthcare reforms that included more health and benefits applications. This resulted in higher average premiums for insurance products, which ultimately resulted in higher revenues. Paychex management believes that the company’s growth in this segment is likely to continue through 2016 with a significant number of clients yet to include the affordable care act compliant products on their platforms. ^[2]

Margins And Outlook For FY’16

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. 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 by 70 basis points over the previous year to 42.6% for FY 2015. Similarly, Paychex’s operating expenses were up by about 6% y-o-y to $855 million through the first two quarters of FY’16. However, the effective tax rate for the quarter was significantly lower than the prior year period due to a net tax benefit from customer software used in the previous fiscal year. ^[5] As a result, the company’s EBITDA margin improved for the quarter on a y-o-y basis. According to our estimates, Paychex’s adjusted EBITDA margin for the combined six month period in fiscal 2016 was about 80 basis points higher than the year-ago period at 45.0%.

The company expects payroll revenues through FY’16 to grow at 4-5%, while HRS revenues are likely to sustain a double-digit growth rate. However, Paychex could be affected by an inconsistent pattern in the growth for small business jobs. While many of the causes of the weakness were temporary and have faded, the slowdown in mining and oil and gas industry hiring will likely persist. Despite uncertainty in small business growth and slowdown in certain industry sectors, Paychex’s pricing increases and steady growth in its client base are likely to continue to help drive its top line.

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1. Paychex Reports Second Quarter Fiscal 2016 Earnings, Paychex Press Release, December 2015 [↩]
2. Paychex Q2 2016 Earnings Call Transcript, Seeking Alpha, December 2015 [↩] [↩] [↩]
3. Small business is back: Paychex CEO, Yahoo! Finance, September 2015 [↩]
4. One in Two Large Employers Unprepared to Fully Comply with the Affordable Care Act, ADP Report, January 2015 [↩]
5. Paychex SEC Filings 8-k For Q2’16, SEC, December 2015 [↩]