ADP Earnings: Sustained Growth From PEO Services Continues To Drive Results

by Trefis Team
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ADP (NASDAQ:ADP) announced its fiscal Q3 2017 earnings on May 3, reporting a 5% annual increase in net revenues to $3.4 billion. [1] The company reported a 2% growth in payroll processing revenues to $2.3 billion in the March quarter, a trend consistent over the last 8-10 quarters. Similarly, ADP’s PEO services (or HR outsourcing and other services) revenues were up 12% over the year-ago period to $970 million. While revenue growth was consistent compared to previous quarters, adjusted earnings before interest and taxes (EBIT) was up only 4% to $838 million. As a result, ADP’s adjusted EBIT margin was down 20 basis points to 24.6% for the quarter as shown below. Lower margins were attributable to a slight slowdown in revenue growth, complemented by certain strategic initiatives to improve the service model that led to lower margins in the PEO services segment. [2] However, lower taxes during the quarter helped the company improve its net earnings per share by almost 12% y-o-y to $1.31.

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Performance Across Revenue Streams

ADP has witnessed double digit growth in PEO Services revenues over the last few years, with many employers switching to HR outsourcing as an option. As a result, the contribution of PEO Services revenues to the company’s top line has increased from 17% in 2010 to 26% in 2016, with revenues growing at early teens in each of the last 7-8 years. This trend has continued in fiscal year 2017 for the company, with combined revenues for the first three quarters growing by over 12% y-o-y to $2.7 billion. ADP has reported a corresponding increase in the number of worksite employees in the same period. At the end of March, the total number of ADP’s worksite employees was around 12% higher than the year-ago period, reaching 471,000 employees. We forecast ADP’s total worksite employees to increase to almost 480,000 employees by the end of fiscal 2017 and subsequently to almost 600,000 employees by the end of the decade.

 

Comparatively, ADP’s core payroll processing business grew at high single digits in the early part of this decade. While this has slowed down to around 4-5% over the last couple of years, the company has observed a steady growth rate in every quarter in that period. ADP has attributed the steady growth to a 1-2% increase in the average fee per client complemented by a 2-3% increase in the number of clients served. In the, March quarter, ADP’s payroll processing revenues were up by 2% to $2.3 billion. We forecast the company to continue to witness consistent growth in this segment in the long run.

 

ADP generated around $111 million from interest on client funds, which was 9% higher on a year-over-year basis. The average clients funds balances for the quarter were around 2% higher on a y-o-y basis to $27.3 billion while the average implied annualized yield on the client funds for the March quarter was 10 basis points higher than the comparable prior year period at 1.63%. Higher interest rates could help improve yields on interest-bearing assets for ADP in the long run.

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Outlook For Q4 & Fiscal 2017

ADP’s management expects to continue to witness a 4-5% growth in payroll processing revenues while PEO services revenues are expected to be up 12-13%. [2] For fiscal 2017, we expect ADP to sustain revenue growth in both the Payroll Processing & PEO Services businesses. Payroll processing revenues could be up 5% for the fulll year to $8.6 billion while PEO services revenues could be up 13% y-o-y to $3.5 billion. We forecast ADP’s adjusted EBITDA margin to improve by around 90 basis points through the year, which is in line with the company’s guidance. Resulting earnings per share could be up by 16% y-o-y to $3.78, which is slightly higher than the Reuters’ consensus estimate of $3.65.

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See our full analysis for ADP.

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Notes:
  1. ADP Reports Third Quarter Fiscal 2017 Results, ADP Press Release, May 2017 []
  2. ADP Q3 FY 2017 Earnings Call Transcript, Seeking Alpha, May 2017 [] []
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