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Investment Overview for Paychex (NASDAQ:PAYX)

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1. Latest Earnings

Paychex delivered a mixed performance for its fiscal fourth quarter. The company reported adjusted earnings of 63 cents per share, which missed the consensus estimate of 65 cents. However, total revenues increased by 16% y-o-y to $980.5 million - marginally beating the consensus estimate. Moreover, for full-year 2019, total revenues increased 12% to $3.8 billion while adjusted EPS grew by 4% to $2.86. For fiscal 2020, we expect Paychex’s revenue to increase by about 11% to $4.2 billion while net income margin is expected to stay around 27.6%.

2. New Products Could Improve Customer Satisfaction

Paychex announced its plans to embed two new products - Paychex Flex Onboarding Essentials and a do-it-yourself (DIY) handbook builder – into two of its existing mid-level HCM offerings. While the Flex Onboarding Essentials tool will enable Paychex's existing clients to ensure paperless and efficient onboarding of their new hires, the DIY handbook builder will allow them to create customized handbooks to guide their employees and ensure compliance of their policies.

With these new products, Paychex aims to cater to two of the biggest pain points of its clients without charging any additional cost. Although these new products will not have a direct impact on Paychex's revenue or earnings, they could go a long way in enhancing its customer satisfaction and brand value, which will be beneficial for the company in the long term.

3. Oasis Acquisition To Augment Its HR Outsourcing Presence

In December 2018, Paychex announced the acquisition of Oasis Outsourcing Group Holdings, L.P. (Oasis), along with all its operating subsidiaries, for a purchase price of approximately $1.2 billion. Oasis is the largest privately owned PEO in U.S.,primarily providing HR solutions to small and medium-sized businesses, which is also one of Paychex's key areas of focus. As the focus and operations of the two companies are largely aligned, the deal is a strategic fit and is expected to strengthen Paychex's leadership position in the HR outsourcing market. The deal should not only allow the company to expand its presence in newer markets and offer better HR solutions, but will also enable it to increase its footprint in its key market - small and medium businesses.

4. Rate Hike Could Lead To Higher Interest Revenues

Paychex's interest revenue on funds held for clients grew by approximately 27% in fiscal 2019 driven by the improving interest rates. Average interest rate on client fund increased by 40 basis points to 2.0% in 2019, primarily as a result of a 50 basis-point rate hike by the Fed in the fiscal 2019 (May'18-19). Based on the current interest rates scenario, Paychex estimates its interest on funds held for clients to achieve high single-digits growth for the fiscal year 2020. However, if the Fed further increases the interest rates in Fiscal 2020, then the company is likely to enjoy higher interest revenue in the 2020.

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Below are key drivers of Paychex's value that present opportunities for upside or downside to the current Trefis price estimate for Paychex:

Payroll Processing

• Number of Paychex Payroll Clients: We currently forecast the number of payroll processing clients for Paychex to increase going forward from over 670,000 in 2019 to 720,000 by the end of the Trefis forecast period in 2026. However, there could be a 7% downside to the Trefis price estimate if Paychex's payroll accounts fall to 600,000 due to competition from cheaper competitors and online payroll processing companies.
• Paychex Payroll EBITDA Profit Margin:EBITDA margin for Paychex's payroll processing business has hovered around 42% over 2010-18. The figure declined to 41.1% in 2019, as operating expenses grew at a faster pace as compared to revenues for the division. We forecast the margin to further decline before increasing to 40.6% by the end of the Trefis forecast period. There could be a 9% upside to the Trefis price estimate if Paychex's payroll processing EBITDA margin continues to increase in the future, reaching around 50% by the end of our forecast period.

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Paychex offers payroll processing to businesses of varying sizes around the globe. Payroll processing includes 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.

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Number of Paychex Payroll Clients

The number of payroll clients is an important driver of Paychex revenues. As of 2019, Paychex had over 670,000 Payroll clients with an average of roughly 18 employees per client and over $155 in annual revenue per employee.

Human Resources Outsourcing

In addition to Payroll Processing, Paychex offers HR Outsourcing, whereby Paychex takes over the HR operations of clients. This segment has seen significant growth in recent years, as the number of clients served has increased from 143,000 in 2008 to over 321,000 in 2019.

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Declining unemployment rates in the U.S.

During the recession, unemployment rates in the U.S. had increased drastically as many businesses laid off employees to reduce costs. The U.S. unemployment rate peaked at 10% in October 2009. However, driven by a recovery in the U.S. economy, businesses have began hiring again. Post October 2009, the unemployment rate has been declining month-on-month. In May 2019, the unemployment rate stood at 3.6%, a ten year low. Declining unemployment rates are beneficial to Paychex since it could lead to an increase in its checks per payroll metric. This metric indicates the number of employees per client that Paychex caters to and an increase in this number will have a positive impact on Paychex's revenue.

Growing jobs in small and medium sized businesses

From 2009 to 2018 jobs in the small and medium businesses in the U.S. have grown at almost 8% driven by a recovery in the U.S. economy. Paychex's core payroll services are targeted at small and medium-sized (less than 50 employees) businesses. Growth in jobs at these businesses will help drive Paychex's clients and revenues.

High small business exposure

Small businesses are the most vulnerable in economic recessions and have high bankruptcy risk. Paychex is more exposed to the risks of small businesses than its primary competitor ADP.

How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

1. We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
2. We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

See more on: DCF Methodology

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