HR Outsourcing & Services To Drive Long-Term Growth For Paychex

by Trefis Team
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Paychex (NASDAQ:PAYX) has witnessed solid 8-9% revenue growth over the last few years, with fiscal 2016 revenues growing at 7.7% to just under $3 billion. Paychex’s HR outsourcing and other services business drove much of that growth, due to a 13% revenue increase to $1.3 billion in the fiscal year ended mid-2016. Similarly, the company has witnessed a 17-18% increase in revenue in this segment over the previous two years. Paychex’s primary client base in this domain has been primarily small and medium sized businesses, with competitor ADP (NASDAQ:ADP) dominating the market for large businesses. According to our estimates, HR Outsourcing and Services makes up around 40% of our $55 price estimate for Paychex’s stock. Our current price estimate is roughly 10% lower than the current market price. Paychex’s stock price has increased from $54 in mid June to around $60 in late July after the company reported a strong set of Q4 and FY 2016 results.

See our complete analysis of Paychex Here

Key Growth Metrics For HR Outsourcing & Services

Paychex offers various services ranging from PEO (Professional Employer Organization) service, retirement services and insurance service. PEO services are a comprehensive package of services such as payroll, compliance, employee benefits administration, 401K retirement savings plan management and onsite trained HR representatives, on which the company earns a fee per employee for these services. Retirement services include plans from which employers can choose how to manage their retirement funds in terms of investments on which the Paychex earns 30-40 basis points on client funds. Insurance services cover employees who need to be paid while on leave due to job-related injuries. It helps clients manage the payment of premiums throughout the year; and then insurance covers payments if employees are injured.

Over the last few years,  Paychex’s HR outsourcing and services revenue has grown at a consistent 12-13% with growth driven by an increase in the number of clients served, complemented by a price increase in the same period. As a result, the contribution of HR Outsourcing and Services to the company’s top line has increased from 27% in 2010 to 40% in 2016. As shown in the table below, the total number of clients served by Paychex has grown at a CAGR of over 7% to almost 260,000 clients in 2016. Correspondingly, the average fee charged by Paychex per client has risen by almost 7% a year since 2011 to $4,500 per client in fiscal year 2016.

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Within Paychex’s client base, the number of HR outsourcing clients has grown at 11-12% in the last two years while retirement and insurance clients have increased at around 5-6%. We expect the HR Outsourcing and Services to continue to grow, albeit at a slower pace compared to the last few years. With growth in jobs for small businesses likely to continue, Paychex’s HR outsourcing business should continue to reap benefits in this space. [1] We forecast Paychex’s total HR services clients to increase from under 260,000 in fiscal 2016 to over 330,000 by the end of our forecast period.

 

Similarly, we forecast Paychex’s average fee per client to increase from $4,500 in 2016 to almost $6,000 by the end of our forecast period. You can modify the interactive charts below to gauge the effect a change in the total customers or average fee per client will have on our price estimate for the company.

 

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Revenue And Margin Growth For 2017

As demonstrated above, we expect HR Outsourcing and Services to drive much of the top line growth for the company in the long run. Below we take a look at our full year forecasts for Paychex.

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Paychex’s cash operating expenses have increased roughly in proportion to its revenue growth over the last few years. As a result, the company-wide EBITDA margin (adjusted for non-cash expenses) has remained between 43.5% and 44.2% since 2012. However, with the Fed increasing interest rates in late 2015 for the first time in a decade, it should help boost Paychex’s interest income over the long term. Consequently, we expect the revenue growth from client funds interest to lead to a minimal rise in expenses. As a result, the revenue growth can translate to a gradual improvement in margins, as there are minimal expenses related to interest income. Despite most of the revenue growth coming from HR services, the interest income is likely to lead to healthier margins for the company.

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Notes:
  1. Small-business job growth resumed in June: IHS-Paychex, CNBC, June 2016 []
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