ADP’s Year In Review: HR Services Drive Top Line Growth, Improve Profitability

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ADP
Automatic Data Processing

ADP (NASDAQ:ADP) has had a successful year, reporting a sustained period of revenue growth. ADP’s payroll processing revenues have grown in the single digits over the last few years, while HR outsourcing revenues have grown year-over-year in the mid-teens. This trend has continued in 2016 thus far, with both payroll revenues and HR outsourcing revenues driving growth. Revenues generated from interest on client funds have remained roughly flat over the prior year period due to limited increase in the interest yield. Below we take a look at how ADP performed this year and how individual segments drove growth.

Steady Growth For Core Business

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The company’s core client base consists of large enterprise clients, with small and medium businesses (SMBs) making up a smaller proportion of the client base. ADP’s PEO services business have driven much of the top line growth in the last few years, but Payroll Processing continues to be the largest revenue segment within the company. ADP reported a 4% annual growth in payroll processing revenues to $8.2 billion this year driven by a 2-3% increase in its payroll clients. This increase was complemented by a 1% growth in the fee earned per client as shown below.

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On the other hand, revenues generated by HR outsourcing and other services (or PEO services) grew at 16% for the year to just under $3.1 billion. ADP’s comprehensive scope of HR services include health and welfare benefits services, compliance services, 401k retirement savings plans and worker insurance services for enterprise clients, for which ADP offers employees to work at client sites. Correspondingly, the total number of worksite employees under ADP’s HR division has increased at a CAGR of almost 13% over the last few years. This trend continued this year, with the company reporting a 12% increase in its total worksite employees to 432,000 by the end of June and almost 450,000 worksite employees by September.

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In addition to the segments mentioned above, ADP could witness strong growth in its Client Funds Interest segment if interest rates pick up in the coming years. The Fed has indicated that another interest rate hike is likely in the near term. [1] Since the operating expenses of the Client Funds Interest segment are fixed in nature, revenue growth directly translates to an improvement in margins.

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In terms of profitability, ADP’s adjusted EBITDA margin stood at just under 21% in 2015, which improved slightly in 2016. It should be noted that the key contributor to the EBITDA growth was the corresponding increase in revenue, while the impact of changes in operating expenses is negligible for ADP, as shown below. With the interest rate hike likely to improve ADP’s net yield on interest-bearing assets, the company-wide EBITDA could grow at a faster pace in the coming years.

In the long run, we forecast ADP to sustain revenue growth in Payroll Processing & HR Outsourcing. We forecast mid-single digit growth in Payroll Processing revenues while HR Outsourcing and Other Services segment should continue to witness strength in its service offerings. With interest rates helping improve margins, we forecast, ADP’s EBITDA margin to improve by over 2 percentage points in the next three years, as shown below.

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We maintain our $86 price estimate for ADP, which is around 15% lower than the current market price. You can modify the interactive charts in this note to gauge how a change in  individual drivers can have on our price estimate for ADP.

See our full analysis for ADP

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Notes:
  1. The Federal Reserve looks ready to roll with an interest rate hike in December, CNBC, November 2016 []