Automatic Data Processing (NASDAQ:ADP), the largest payroll processing and human capital management solutions provider in the U.S., released its earnings results for the first quarter of fiscal year 2014 on Wednesday, October 30. All of the company’s business segments delivered strong revenue growth. Payroll Processing, the company’s biggest division, posted $2.5 billion in revenues, representing year-over-year growth of 8%. The Dealer Services division also demonstrated strength with revenues rising by 7%.
ADP’s total revenue increased 8% y-o-y to $2.8 billion, better than management’s guidance of 7% growth, despite lower returns on the client funds portfolio. Rising by 9% y-o-y, net income grew faster than revenues to $329 million due to a lower effective tax rate. 
Our current price estimate of $70 for ADP stands at a discount of over 5% to the market price.
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Healthy Employment Scenario Supports Payroll Processing
Employer Services and PEO Services are ADP’s major businesses in payroll processing. Employer Services revenue increased 8% y-o-y in Q1 FY 2014 to $2 billion, while PEO Services revenue grew by 12% y-o-y to $500 million. Both these businesses have a direct relationship with the U.S. job market. The job market has picked up in the last few months across all segments of the U.S. economy, including small, medium and large businesses.
According to ADP’s monthly national employment report, over 70,000 jobs were added in the small business (1-49 employees) segment in both August and September; the medium business segment (50-499 employees) and the large business segment (>500 employees) added more than 100,000 jobs each in the two months combined.  Overall, the employment scenario improved and benefited ADP in the form of 2.6% y-o-y more client employees.
Falling Client Interest Revenue Still A Drag
The interest on funds held for clients fell by more than 15% y-o-y during the quarter. A consistent decline in interest earned on client funds over the recent years has been the most significant drag on ADP’s earnings. The company earned $684 million as interest on client funds in FY2008, which declined to $421 million in FY 2013, even though average client fund balances increased from $15.5 billion to $19.2 billion during the same period. This was the result of a low interest rate environment in the U.S. ADP sees the decline in interest earned on client funds to be bottoming out in terms of the size of the year-on-year decline, thanks to rising yields on U.S. Treasuries. 
We are in the process of updating our $70 price estimate for ADP based on the recent quarterly results.Notes: