Summary
- ADP is an industry leader and benefits from an economy of scale.
- It's strongly benefitting from a tight labor market and is rolling out system improvements.
- While ADP isn't cheap, it's well set up at present for growth at a reasonable price.
Moat worthy companies come in all shapes, sizes, and forms. However, they share a commonality in that they generally have dominant positions in their respective fields and enjoy significant economies of scale.
This rings especially true for Automatic Data Processing ( ADP ), which likely exemplifies the above points. ADP has done rather well since my last look at the stock in May of 2021, giving investors a 19% total return, far surpassing the 0% change in the S&P 500 ( SPY ) over the same timeframe.
As shown below, ADP has taken a dip over the past couple of months, and currently far off its 52-week high of $275. In this article, I highlight why this opens a good entry point for dividend growth investors, so let's get started.
ADP Stock (Seeking Alpha)
Why ADP?
ADP has been around for over 70 years, and is a comprehensive global provider of cloud-based human capital solutions that unite HR, payroll, talent, tax, and benefits administration.
It’s the largest domestic provider of payroll services, and has longstanding and loyal customer base with many of the largest employers in the U.S. This also serves as a moat around ADP’s business, as changing providers results in high switching costs.
ADP is benefitting from a strong labor market. This is reflected by its recent strong fiscal second quarter results, with revenue climbing by 9% YoY (10% organic constant currency growth) to $4.4 billion. True to its form ADP is seeing strong operating leverage as a result of its significant scale.
This is supported by adjusted EBITDA margin improving by 120 basis points to 24.3%, driving adjusted EBIT to grow at a faster rate than revenue at 15% YoY. As shown below, ADP scores an A+ grade for profitability, with margins that are well in excess of the sector median.
Seeking Alpha
While the recent headlines around tech-centered layoffs may have spooked some investors, it appears that the rest of the labor market hasn't gotten that memo, as the recent January jobs report showed very strong 517,000 jobs growth. Plus, ADP continues to build upon its leadership position with innovative new tools around Payroll and Retirement Plan services, as noted by management during the recent conference call :
Our Next Gen Payroll engine is a prime example of how we're modernizing the back-end of our solutions, and we continue to offer it to a broader set of new mid-market clients. In brand new solutions like Roll in our Next Gen HCM platform position us to address certain HCM opportunities more fully than before. These product enhancements are designed to drive win rates and retention even higher, and we have tremendous opportunity in front of us.
What we've designed makes life easy for our clients and partners, improves the financial wellness of their employees, and sets us apart in the market. Our robust 401(k) solution with thousands of different investment options is not only clean and intuitive, thanks to our new UX framework, but is also deeply integrated with RUN and Workforce Now.
Meanwhile, ADP maintains a very strong AA- rated balance sheet, which is just a couple notches below the AA+ rating of the U.S. government. While ADP's 2.2% dividend yield isn't particularly high, it does come with a 58% payout ratio, a strong 13% 5-year dividend CAGR, and over 25 years of consecutive growth, making ADP a dividend aristocrat. As shown below, ADP scores A and B grades for dividend safety, growth, yield, and consistency.
Seeking Alpha
Admittedly, ADP still isn't cheap at its current price of $225 despite its material drop since the start of December. However, it's reasonably priced for long-term growth with a forward PE of 27.8, sitting just below its normal PE of 28.7 over the past decade. Analysts estimate strong 16% EPS growth this fiscal year, followed by 11% annual growth over the next 2 years, and have an average price target of $245, implying total return potential in the low-teens in the near term.
ADP Valuation (FAST Graphs)
Investor Takeaway
ADP is the clear leader in its respective field, with a very long operating history and long-standing relationships with leading U.S. companies. This network effect and scale gives ADP a strong competitive advantage by enabling it to spread corporate and systems costs over a wide customer base. Meanwhile, ADP is set to continue benefitting from a historically low unemployment rate and is introducing new innovative solutions. At the current price, ADP is wonderfully set up for growth at a reasonable price.
For further details see:
Automatic Data Processing: Buy The Drop On This DGI Giant