Paychex Earnings: HR Outsourcing & Services Continue To Drive Top Line Growth

Paychex (NASDAQ:PAYX) announced its Q3 FY 2017 earnings on March 29, reporting a 6% annual growth in revenues to $796 million. ^[1] The company has reported high single digit growth over the last few quarters, a trend which continued through the third fiscal quarter as well. Over the last few years, Paychex has reported double digit growth in HR Outsourcing and Services revenue, driving much of the company’s revenue growth, while core Payroll Processing revenues have grown in low single digits in the same period. Keeping up the trend, HR outsourcing revenues were up 12% to $336 million for the third quarter, while payroll processing revenues were up 2% to $447 million. A similar trend was observed for the three quarters of fiscal 2017 combined, as shown below. It is interesting to note that competing HR management and payroll processing firm ADP (NASDAQ:ADP) has also witnessed a similar trend in its payroll processing and HR outsourcing businesses over the last few years.

Third Quarter Performance

Paychex has been dominant in the HR outsourcing market for small and medium-sized businesses (less than 500 employees), leading to strong revenue growth over the last few quarters. In the last few years, the number of insurance clients and retirement services clients serviced by Paychex have grown at a steady 4-6%. Comparatively, the total number of HR outsourcing clients serviced by Paychex has risen in the low single digits. At the end of fiscal  2016 (ended May), the total number of HR outsourcing clients served by Paychex stood at 35,000 while insurance clients and retirement services clients stood at 150,000 and 74,000, respectively. The company reported strong growth across the various HCM service streams, leading to 12% growth in HR outsourcing and services revenues to $336 million for the quarter. ^[1]

 

According to the most recent data in the small business jobs index released by Paychex, the index stood at 100.78 for February, which was flat over the previous year. According to the report, small business job conditions have broadly improved in the three month period from November through February across all industries and regions in the U.S. ^[2] This is a healthy sign for Paychex, as the total number of clients served by these companies is likely to continue to increase, especially because small and medium businesses form its core customer base. We forecast the total number of clients to continue to increase at 4-5% through the end of our forecast period.

Comparatively, the total number of payroll processing clients served by Paychex has increased at 1-2% in the last few years, complemented by a 2-4% price increase. ^[3] We expect the trend to continue, with payroll processing clients served forecast to increase by around 2% for the year to 613,000 clients.

 

We forecast Paychex’s net revenues to grow by around 7% for the full year to almost $3.2 billion – in line with the company’s expectations. Payroll revenues are expected to grow at around 4% to $1.8 billion while HR outsourcing revenues could be up by around 13% to over $1.3 billion. ^[4]

Given that the expenses in the client funds interest segment are fixed in nature, the top line growth could directly translate to an improvement in company-wide EBITDA. We forecast Paychex’s adjusted EBITDA to increase by 10% to $1.4 billion while the EBITDA margin could improve by 90 basis points through FY 2017, as shown below.