Strong Growth In Client Base, Improving Cost Structure Drive ADP’s Profits

by Trefis Team
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Automatic Data Processing (NYSE:ADP) reported a strong performance for its fiscal Q3 recently, with the company’s net sales improving to $3.8 billion (up 4% y-o-y), and the diluted EPS figure coming in at $1.73 (up 16% y-o-y). The bottom line received a boost from the company’s continued execution of transformation initiatives as well as operating leverage – which led to an EBIT margin expansion of 140 basis points. The company’s efforts to meet the evolving needs of the global human capital management market is delivering positive results, as it has improved the company’s retention rate while also allowing it to rapidly add new business bookings (+10% y-o-y).

We have summarized our full year expectations for ADP based on the company’s guidance and our own estimates in our interactive dashboard – How Did ADP Fare In Fiscal Q3 And What Is The Forecast Full-Year?  In addition, here is more Trefis Internet & Software Services Data.

A Quick Look at ADP’s Revenue Sources

ADP reported $13.3 billion in Total Revenues in Fiscal 2018. This included 3 revenue streams:

  • Payroll Processing: $9 billion in FY 2018 (67% of Total Revenues). This includes ADP’s traditional payroll processing and tax filing services
  • PEO Services: $3.9 billion in FY 2018 (29% of Total Revenues). ADP’s Professional Employment Organization (PEO) solutions segment provides outsourcing solutions based on co-employment
  • Interest on Client Funds: <$0.5 billion in FY 2018 (4% of Total Revenues). This represents the interest ADP earns between pay periods on funds received from clients.

Key Takeaways From ADP’s Q3 Results  

PEO Services Is Driving Growth In Profits

  • ADP’s PEO Services business continues to expand as more companies explore the option of using HR outsourcing. ADP’s revenue from its PEO services have grown at around 14.5% annually over the last five years. For Q3, revenues were up 6% year over year. These gains were driven by an 8% increase in average worksite employees for the reported quarter to roughly 554,000. As businesses outsource their HR services, this figure is likely to witness strong growth in Q4 2019 and beyond.
  • PEO segment’s year-to-date revenue growth has been just over 9%, and we forecast the PEO services revenue to increase in the low double-digits range in the near term. This will likely be driven by new PEO Services clients as well as by growth in the company’s existing clients.

Payroll Processing Remains The Core Business

  • While ADP’s PEO Services business has driven much of its top-line growth over recent years, payroll processing continues to be its core business – contributing approximately 66% of total revenues. In Q3, the company’s revenue from its payroll processing services increased by approximately 3% compared to the prior-year quarter thanks to 10% increase (y-o-y) in Employer Services New Business Bookings. The segment’s margin expanded by 230 basis points primarily due to improvements in the overall cost base, partially offset by foreign exchange headwinds.
  • We forecast revenues for this segment to increase in mid single-digit range in the near term primarily driven by an increase in New Business Bookings and expected benefits from earlier acquisitions. With a large and growing customer base and a high client retention rate (over 90%), the company is in a strong position to generate sustained revenue growth in this segment.
  • Additionally, the company is focused on launching new innovative products that help simplify complexities for their clients and their workers. ADP recently launched a new brand initiative under the name “What Are You #WorkingFor?” Though, no initiative is individually significant enough to call out, collectively they help to drive net productivity improvements across the business. These initiatives should help APD differentiate its offerings from competitors while also helping it consolidate its leadership position in the payroll processing industry.

Full-Year Outlook

  • ADP’s management raised its outlook for fiscal 2019 in view of strong expected growth across segments. The company expects revenue to improve 6-7% compared to 2018, while adjusted earnings are expected to grow 19-20% – up from the previous range of 17-19%. ADP also expects New Business Bookings to now grow 8-9% for fiscal 2019 – up from the earlier guidance of 6-8%
  • Based on our forecast, ADP’s adjusted EPS for full-year 2019 is likely to be around $5.17. Using this figure with our estimated forward P/E ratio of 30x, this works out to a price estimate of $155 for ADP’s shares, which is slightly below the current market price.

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