Probing Paychex (PAYX): A Follow-Up

- Paychex (PAYX) provides comprehensive payroll, human resource and benefit outsourcing to small and medium-sized companies with 10 to 200 employees.  It served about 554,000 clients as of May 31, 2009 (down 3% from 2008) according to its latest annual report. 

- PAYX was the Online Stock Study for November 2009 at the Better Investing website that was led by Ron Bruyn, a Director of the BI Orange County (CA) Chapter.  Study materials available for downloading include Ron’s SSG, the Presentation Slides, Value Line, and other handout material.

- After a three month delay, the recorded session is finally available at the BI website.  A Consensus SSG was nearly, but not totally, completed and I waited for the recording in the hopes that it would explain why (it didn’t).

 Company Background

- Morningstar considers that PAYX has a “wide economic moat” which constitutes a completive advantage.   Switching to another company is costly, PAYX has a respected brand name, and clients are reluctant to entrust their payroll cash and other HR functions to an unknown or unproven competitor.

- In FY 2009, PAYX earned about 4% of its revenues by essentially doing nothing due to the “float”, cash that results from the lag between when PAYX receives and then pays payrolls.  During the lag, Paycheck invests and earns interest on these funds.

** Interest from the float was way down last year, some 43%, from $131.8M in 2008 to $75.5M to 2009.

** Morningstar expects the float to earn 3.0% annually during the next 5 years.

- In its 2^nd Q ending November 30, 2009, PAYX’s total revenues were down 5.3% and EPS declined 10.3%.

- In addition to its core payroll business, PAYX has branched out to provide retirement/401(k) record-keeping services, workmen’s compensation insurance, and comprehensive HR outsourcing.  Revenue from these services has grown to about 25% of the company’s total revenue.

** PAYX has recently entered the health and benefits services market which it believes offers significant room for revenue and profitability growth.

SSG Discussion

- The following table compares Ron’s SSG to mine.  I also updated both SSGs with the current price and data, but left all judgments unchanged.  After the table, I discuss several issues raised by the comparison.

Paychex               (PAYX)	RonB-1            (initial)	Armin-1            (initial)	RonB-2 (updated)	Armin-2 (updated)
Date	9-28 (price)    11-02 (data)	11-6-09	2-12-10	Same
Data	S&P	Same	Same	Same
Price	$29.29	$30.37	$29.53	Same
52 week High & Low Price	$33.67 & $20.31	$32.88 &            Same	$32.88 & $20.31	Same
Last Q of Reported Data	Q1 ending 8/31/09	Same	Q2 ending      11-30-09	Same
Software Used	TK 6	TK 5	Same	Same
Project Growth From End of	Last Q	Same	Same	Same
Sales Growth	6.00%	10.00%	6.00%	10.00%
EPS Growth	7.40%              (from PP)	10.00%	7.40%	10.00%
High PE	24.0	Same                 (from 2008)	24.0	Same                  (from 2008)
High EPS	$2.01	$2.17	$1.96	$2.21
High Price	$48.20	$54.50	$47.00	$53.00
Value Line Est High Price = $45-60 as of 8-21-09 and $45-55 as of 11-20-09
Low PE	20.0 (Ron) 13.7 (Cons)	13.7                         (from 2008)	20.0	13.7            (from 2008)
Low EPS	$1.48	$1.41 (ttm)	$1.48	$1.41 (ttm)
Low Price	$20.30            (Ron-recent severe low)	$19.30                (low EPS x         low PE)	$20.30 (recent severe low)	$18.80               (low EPS x        low PE)
Upside/Down	2.1	2.2	1.9	2.2
% Payout	63.9%	Same	63.9%	Same
Total Return	13.1%	15.1%	12.4%	15.1%
SSG Buy Under	N/A	$28.10		$27.73
RV/PRV	86.3/80.3 (2004 all out, 05 Hi PE out)	79.8/72.8           (no outs)	89.6/83.3(same outs     as Ron-1)	80.3/72.8           (no outs)
RV/PRV                 (no outliers)	80.3/72.8	79.8/72.8	80.3/74.6	Same
Quality	A+	Same	Same	Same
PTPM – 5 yr ave	40.00%    trend down	Same               Same	Same             Same	Same                Same
ROE – 5 yr ave    End Equity	N/A	33.87%               trend up	Same              Same	Same                  Same
ROE – 5 yr ave    Start Equity	34.30%   trend up	Same                  Same	Same               Same	Same                Same
Debt to Equity –  5 yr ave	-0-                    trend even	Same                 Same	Same              Same	Same                 Same

The Current Price

- The Online Stock Study was held on November 4^th, but September 28^th was the (old) price date that Ron used for his presentation.   Worse, his SSG shows that the data was updated November 2^nd, but inexplicably not its (even older) price.

** Good practice is to keep our SSGs updated with the current price and current data, especially when we share them.

Estimating Future Sales Growth

- Ron gave the online participants 5 options to estimate PAYX’s future sales growth for the next five years: 13.10%, its ten-year historical growth rate; 7.00%, Value Line’s estimate; 6.00%, Ron’s estimate; 5.50%, the one-year estimate from YahooFinance; and -6.30%, its sales growth in the most recent quarter.

** The recorded session reveals that Ron’s 6.00% estimate was based on Value Line’s dollar estimate for the next 3-5 years converted to a rate.  It looks like a mistake was made to think VL offered two rates for the same thing.

- The Consensus chose 6.00% (Ron’s estimate from VL), but 7.00% (VL’s estimate) was very close in second place.

** VL’s 7.00% estimate was actually for sales per share growth and (sadly) Value Line does not make an estimate for sales growth. 

** Zacks.com was estimating 10.13% sales growth for the next 5 years which Ron did not mention while Morningstar, which often makes a sales estimate in its narrative report, made none this time.

- The 13.10% and -6.30% choices were neither realistic nor meaningful options.  PAYX’s sales growth has declined every year for the past 10 years from 13.10% in 1999 to 10.70% (5 years ago) to 7.70% (3 years ago) to 0.80% (last year).

Estimating Future EPS Growth

Ron’s SSG:

- Ron offered the participants 5 options: 6.00%, the same as their Sales growth choice; 13.10%, PAYX’s ten-year historical growth rate; 6.50%, VL’s estimate; 7.40%, Ron’s estimate based on the Preferred Procedure; and 13.30%, the five-year estimate from YahooFinance.

** The 13.30% estimate from Yahoo Finance might have indicated to Ron and the participants that a 7.40% estimate was too low.

- The Consensus chose 7.40%, Ron’s estimate.

Armin’s SSG:

- When I did Armin-1, Value Line had made a low-ball estimate of 6.50% compared to the other six analysts I checked.  They were averaging 12.89% long-term EPS with YahooFinance high at 13.30% and Zacks.com low at 12.13%.

** The six estimates were close with only 1.17% separating the lowest from the highest.

- I chose to estimate 10.00% EPS which was the very lowest of the seven analysts at CNNMoney and the nine analysts at Reuters.com (with both groups ranging from 15.0% to 10.0%).

- When I did Armin-2, VL was even more a low-ball and had reduced its estimate to 5.50%.  The other six analysts had slightly lowered their average a smidge to 12.58% (down from 12.89%) with Morningstar.com now high at 13.10% and Zacks.com still low at 12.28%.

- 10.00% was still the lowest estimate at CNNMoney and at Reuters.com.

** For how I estimate EPS for every SSG I do and for the names of the seven estimates I always check, see: Estimating EPS

Forecasting the High and Low PEs

Ron’s SSG:

-  The group was given 5 choices to estimate the Forecast High PE: 28.1, the last five-year historical High PE average; 24.0, the most recent year High PE; 14.8, two times the estimated EPS growth rate or a PEG of 2.0; 10.6, one and one-half times or a PEG of 1.5; and 24.0, the average High PE for the last five years + the current PE / 2.

** The Consensus chose the most recent year High PE (39% of the votes), but Ron’s fifth option was close and in second place (35%).   Apparently unnoticed, both were 24.0.

** I do not use the PEG because one number does not fit all stocks, there’s no agreement on what that number should be or even how it should be calculated.

- Of the five choices Ron offered to estimate the Forecast Low PE, one was “none of the above” and, as a result, was meaningless.  The other four choices were: 20.0, the last five-year historical Low PE average; 13.7, the most recent year Low PE; 7.4, one times the estimated EPS growth rate or a PEG of 1.0; and 20.4, the average Low PE for the last five years + the current PE / 2.

- The Consensus (50% of the votes) chose 13.7, the most recent year Low PE, but Ron chose 20.0, the last five-year average (26% of the votes).  The recorded session does not explain why the Consensus choice was disregarded.  [Why bother having a vote?]

Armin’s SSG:

- High/Low PEs have fallen from 40.1/29.7 in 2004 to 24.0/13.7 in 2008.  I used the lowest High PE in the last 5 years, from 2008.

 Forecasting the Low Price

Ron’s SSG:

- Ron gave the group 5 choices: $29.60, the low PE x the low EPS option and the method most appropriate for growth companies; $28.20, the average low price during the last 5 years; $20.30, the recent severe low price; $20.30, the price PAYX’s dividend will support; and $23.40, 80% of the current price.

- The Presentation Slides show that the participants were not asked to vote.  The recorded session does not explain why there was no voting.

- Ron’s SSG shows that he selected $20.30 as his Forecast Low Price, the recent severe low.

Armin’s SSG:

- I selected $19.30 as my Forecast Low Price, the low PE x the low EPS.

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE)

PTPM:

- The 5-year average PTPM is trending down which is usually a red-flag warning of deteriorating quality and, to me, a signal to check further. To others, it is often a sign to abandon their study.  Ron, on the other hand, ignored the downtrend (Slide 34).

** With S&P data, PAYX is way better than its industry average (40.0% vs 15.4%, Data Processing & Outsourcing Industry.

** With Hemscott/Morningstar data, PAYX is placed in a different industry and is way-way better than its industry average (39.6% vs 6.9%, Staffing and Outsourcing Industry).  Moreover, PAYX ranks first out of 35 companies.

** Therefore, I would not curtail any PAYX study because of this downtrend.

ROE:

- The 5-year average ROE trend is up which is a good sign.

** With S&P data, PAYX is again way better than its industry average (33.8% vs 18.1%) and way-way better with Hemscott data (33.5% vs 10.7%)

Financial Condition

- Value Line gives PAYX an A for Financial Strength, reports no debt, and $315 M in cash and short term securities as of 8-31 (down from $473 M as of 5-31).

- Morningstar says that PAYX is in “excellent financial health” with no debt and the ability to generate a strong cash flow.

- The one-click Annual report spreadsheet by Bob Adams gives PAYX a 48 out of 100 with 9 Bullish results (good things) and 7 Bearish results (not-so-goods):

** The Bullish things include: no debt, sales are increasing (up 1%) and growing faster than cash flow, and ROE is adequate.

** The Bearish not-so-goods include: cost of sales is growing faster than sales and free cash flow should be higher.  Cash flow growth is down 5% and should increase, Bob notes, the same as or better than the company’s sales growth.

** You can get this super-duper, easy-to-use free spreadsheet along with an explanation of its many features by going to My Favorite Links page: click here.

What Does the PERT-A Show?

- The Toolkit software has a nifty feature called the PERT-A (in TK 5) and the Quarterly Trend Analysis (in TK 6).  My favorite part is the last three columns of the Worksheet which show the per cent change by TTM quarter for the growth of EPS, Pre-Tax Profit, and Sales.

** For PAYX, the Worksheet shows 12 consecutive quarters of a decline in all three measures.  This data shows me that PAYX’s performance has been dreadful with no sign of any improvement. The same awful record is also shown on the PERT-A graph, for those who prefer a visual analysis.

- If you are still interested in PAYX, check out my earlier post, Probing the Performance of Paychex (PAYX).

POLL (please leave your answers as a comment):

- How many consecutive “down” quarters will you tolerate before selling any stock?

- How many consecutive “up” quarters do you want before you’d consider buying PAYX?

 

 -Armin

 

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