Probing the Performance of Paychex (PAYX)

 

Paychex (PAYX), with $2B in 2007 revenues, is considered a medium-sized company based on NAIC/BI criteria.  The company provides payroll, accounting, and related services to more than 570,000 businesses throughout the U.S., according to Value Line, most of which are small and medium size firms.  PAYX operates 100 offices in 36 states and Washington, D.C.

 

BobM saw growth rates for EPS and Pre-Tax Profits declining for 9 consecutive quarters (8 for Sales) and wouldn’t buy the stock at this time even though his analysis signaled a strong SSG Buy.  VL also recognized that sales growth has become “sluggish” and pointed out that the Payroll Services Unit, which accounts for 70% of revenue, has been hurt by rising unemployment and a competitive price environment.

 

Here’s a comparison of BobM’s SSG with Take Stock and with two of mine (one with S&P data and the other with Hemscott data, but both with the same judgments).  In the discussion that follows, I’ll also compare PAYX to industry data in order to shed some perspective on its slowing growth.

 

Paychex (PAYX)	BobM	Armin-1	Armin-2	Take Stock
Date	8-19-08	8-26-08	8-26-08	8-26-08
Data	S&P	S&P	Hemscott	Hemscott
Price	$34.40	$34.79	same	$34.05
52 wk High & Low Price	$45.65 & $30.09	$45.65 & $30.09	same	n/a
Project Growth From	last quarter	last quarter	same	unknown
Sales Growth	09.00%	10.00%	same	9.40%
EPS Growth	10.00%	12.00%	same	9.40% initial 7.86% final
High PE	30.0	25.0 (2003 & 2004 out = 32.8)	same	30.0
High Price	$75.30	$68.80	same	$68.60
Value Line Estimated High Price = $55-75 as of 8-22-08
Low PE	19.0	17.9 (2003 & 2004 out = 22.1)	same	20.1
Low Price	$29.80	$24.00 (80% of 53 week low)	same	$34.05 (current price)
Upside/Down	8.9	3.2	same	impossible to calculate
Total Return	18.5%	16.8%	same	15.9%
SSG Buy Under	n/a	$35.20	same	$40.04
RV/PRV (2 outs)	78.2/71.1	81.9/73.0	81.8/73.1	n/a
RV/PRV (no outs)	n/a	71.2/63.4	69.8/62.4	n/a
Quality	n/a	A+	not rated	5.8 (acceptable)
PTPM – 5 yr ave	39.1% trend up	39.1% trend up	38.7% trend up	38.7% trend n/a
ROE – 5 yr ave End Equity	31.4% trend dn	31.2% trend up	30.6% trend up	n/a
ROE – 5 yr ave Start Equity	n/a	31.4% trend dn	30.7% trend even	30.7% trend n/a
Debt to Equity–    5 yr ave	n/a	-0- trend even	-0- trend even	n/a

 

Discussion:

 

– Note that S&P and Hemscott data produce almost exactly the same results.

 

– When I did my SSGs, the analysts were estimating long-term EPS around 14% on average with three sets of analysts (FactSet CallStreet, First Call and S&P) high at 15.00% and VL low at 12.50%; Zacks was 12.99%, Reuters via Morningstar was 13.40%, and the average of the six estimates less one Standard Deviation was 12.99% or 13% rounded.  I estimated EPS at 12.00% for my SSG while Bob used 10.00%.

 

– High & Low PEs have fallen for 5 consecutive years, from 47.1 Hi PE & 33.0 Lo PE in 2003 to 30.1 Hi & 19.3 Lo in 2007.  So, I opted to severely reduce my Forecast PEs to 25.0 Hi & 17.9 Lo.  Forecasting declining trends is, I believe, mostly guesswork.

 

– Take Stock sometimes uses the current price as its low price, which makes no sense to me, and makes it impossible to calculate an implied Upside-Downside Ratio.

 

– Take Stock requires a 3.4 minimum Quality Rating, with 6.7 desired and 10.0 max.  Take Stock gave PAYX a 5.8 which is acceptable, above the minimum and below the desired.  S&P gave PAYX a Quality Rating of A+ which is the highest out of its 8 ratings.

 

– PAYX’s declining growth rates still look pretty good compared to its industry:

 

** Reuters.com reveals that PAYX’s Pre-Tax Profit Margin is substantially better than its Industry Average for the Trailing Twelve Months (41.37% compared to 1.04%) and for the last 5 years (39.07% compared to 10.76%).  Reuters places PAYX in the Commercial & Services Industry.

 

** MoneyMSN.com puts PAYX in a different industry, the Staffing and Outsourcing Industry.  According to MSN, the company’s PTPM is also substantially better than its Industry Average for the last year (41.40% compared to 20.8%) and for the last 5 years (39.10% compared to 19.40%).

 

** Reuters also shows that PAYX exceeds its Industry Average in terms of five growth rates: TTM Sales compared to TTM Sales one year ago (9.51% vs 1.97%); 5 year Sales Growth (13.46% vs 7.34%); EPS Most Recent Quarter compared to Year Ago Quarter (18.86% vs -9.14%); and 5 year EPS Growth (14.97% vs 12.13%).

 

** The picture is mixed at MSN which puts PAYX in a different industry, the Staffing and Outsourcing Industry.  The company exceeds its industry average in terms of short- and long-term Net Income, but lags in two of the other four reported growth rates: Current Quarterly Sales compared to Year Ago Quarter (6.50% vs 8.40%) and 5 year Sales Growth (14.45% vs 36.35%).

 

– One of my favorite investment resources is Wikinvest which reports that PAYX retained a record 80% of its customers in 2007, and the main reason for the 20% loss was that those firms went out of business entirely.  When unemployment rises, firms don’t need to process as many paychecks and, as a result, there is less demand for PAYX’s services.  In May 2008, U.S. unemployment experienced its largest one-month increase in 20 years.

 

– When the economy recovers, the potential demand for PAYX services is tremendous.  Wikinvest explained that 99% of the 7.9M businesses in the U.S. have less than 100 employees and therefore fall into PAYX’s target market.  Of those, only 15-20% are now served by a payroll processing firm which leaves “enormous” potential for growth.

 

– The market has noticed PAYX’s slowing growth and it is now trading close to its 52 week low.  Do you think this a buying opportunity for a high-quality company or a time to wait-and-see?  Leave a comment and let me know.

 

– Armin