Is ADP’s Stock Fairly Priced?

Automatic Data Processing (NYSE:ADP) achieved steady growth in fiscal 2019 (ending June), with the company’s revenues increasing 6% year-over-year to $14.2 billion while net income surged by 22% to $2.3 billion. In addition, the company’s adjusted EBIT margin expanded by 160 basis as the revenue growth was achieved alongside various operating efficiencies. ADP’s stronghold on the payroll processing industry and its ongoing transformation initiatives should help the company achieve steady growth in profits for fiscual 2020

Trefis, in its interactive dashboard ADP Valuation: Expensive Or Cheap? takes a look at the potential outlook for the company and some of the trends that could impact its valuation in the coming year. In addition, here is more Trefis Internet & Software Services Data.

A Quick Look at ADP’s Revenue Sources

ADP reported $14.2 billion in Total Revenues in Fiscal 2019. This included 3 revenue streams:

• Payroll Processing: $9.4 billion in FY2019 (66% of Total Revenues). ADP’s payroll processing services includes the calculation, preparation, and delivery of employee payroll checks. In addition, ADP also provides employee payment, regulatory compliance, retirement services administration among other services
• PEO Services: $4.2 billion in FY2019 (30% of Total Revenues). ADP provides professional employer organization (PEO) services to small business clients, wherein it enters into a co-employer arrangement with clients. This allows ADP to take care of human resources, employee benefits, payroll and workers’ compensation for worksite employee while clients focus on their core operations.
• Interest on Client Funds: <$0.5 billion in FY2019 (4% of Total Revenues). This represents interest income earned by ADP by investing client funds that have not been remitted to applicable tax or regulatory agencies or to client employees in high quality, investment-grade marketable securities.

Key Factors That Could Impact ADP’s Valuation

PEO Services Will Continue To Grow At A Faster Rate Than ADP As A Whole

• 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 12.5% annually over the last five years. For 2019, revenues were up 9.4% year-over-year. These gains were led by an increase in the number of worksite employees served under ADP platform going up from 504,000 to 547,000.
• As more businesses outsource their HR services to focus on their core operations, this figure is likely to grow steadily in FY’2020 and beyond.
• We expect PEO services revenue to increase in the low double-digits range in the FY’2020. This will likely be driven by new PEO Services clients as well as by growth in the company’s existing clients

Payroll Processing Will Continue To Be The Cornerstone 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 2019, the company’s revenue from its payroll processing services increased ~4.5% compared to the prior-year thanks to an 8% increase (y-o-y) in Employer Services New Business Bookings.
• We forecast revenues for this segment to increase in mid single-digit range in FY’20 primarily driven by an increase in New Business Bookings, which is expected to grow 6-8%, and additional 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, ADP continues to execute on its transformation initiatives and remains focused on enhancing its product, service, and operations to maximize value for their clients and shareholders. Looking ahead, therefore, we believe that the company will continue to achieve steady growth in the foreseeable future.

Full-Year Outlook

• For fiscal 2020, we expect revenue to increase by about 6.6% to $15.1 billion while net income margin is expected to expand from 16.2% in FY2019 to about 17.4% in FY2020 due to a combination of operating leverage and the impact from various transformation initiatives.
• Per Trefis estimates, ADP’s EPS for fiscal 2020 is likely to be $6.10. Taken together with a P/E of 28x, this works to a fair value of $170 for ADP’s stock which is slightly ahead of its current market price.

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