2023-11-26 20:31:51 ET
Summary
- Automatic Data Processing is a company that fits most criteria for dividend investors, with a 2.4% yield, consistent dividend growth, and the ability to outperform the market.
- ADP has a strong business model in human capital management, with a focus on expanding its product suite and building a strong global presence.
- The company has a 49-year dividend growth streak, a high dividend safety score, and a strong credit rating, making it an attractive choice for dividend investors.
Introduction
What do dividend (growth) investors care about?
While individual preferences vary, I think investors are looking for businesses with wide moats, plenty of growth opportunities, proven business models, healthy balance sheets, decent yields, consistent dividend growth, and the ability to outperform the market with subdued volatility.
In other words, we try to find businesses that give us elevated returns with subdued risks - the holy grail of dividend investing.
In this article, we'll discuss a company that fits the bill, as Automatic Data Processing ( ADP ) has all of these things.
The company has a 2.4% yield, consistently elevated dividend growth, a healthy balance sheet with an AA- rating (one of the best ratings in the world), a proven business model, plenty of growth opportunities, and the ability to outperform the market.
- Since 1986, ADP shares have returned 14.0% per year, beating the S&P 500's annual performance of 10.5% by a substantial margin.
- The standard deviation during this period was 21.5%, which is relatively low.
- Over the past ten years, ADP shares have returned 15.2% per year, beating the S&P 500's annual return of 11.0%.
- Over the past five years, the performance has been somewhat equal at 11%.
- Since 2020, ADP has returned 13.6% per year, beating the S&P 500 by roughly 340 basis points per year.
In other words, ADP has consistently beaten the market with a favorable volatility profile.
Going forward, I expect that to last, with secular growth opportunities, consistent dividend growth, and other benefits.
That's what this article is all about.
So, let's dive into the details!
ADP's Advanced Business Portfolio
My most recent article on ADP was written on June 27, when I highlighted how important the company has become for both small and large businesses.
Founded just a few years after the Second World War in 1949, ADP may be old, yet it is still a company full of growth opportunities.
ADP is based in Roseland, New Jersey, and specializes in human capital management.
They offer services such as payroll, HR outsourcing, time, and attendance, among others.
Currently, ADP operates in over 30 countries and has the ability to process payroll in approximately 45 countries, making it a global leader in its industry.
Automatic Data Processing
They cater to small businesses and large enterprises alike, providing an extensive suite of HCM products.
ADP's growth strategy is focused on expanding its product suite, continuing HR outsourcing, and building a strong global presence.
According to the company :
Our unmatched experience, expertise, insights and cutting-edge technology have transformed HCM from an administrative challenge to a strategic business advantage. Tailored to meet the needs of businesses of all sizes, we help them work smarter today so they can have more success tomorrow. We serve over 990,000 clients and pay over 39 million workers in 140 countries and territories.
Automatic Data Processing
Using Seeking Alpha data, these services have allowed the company to grow revenue by 5.2% per year during the past ten years.
- Thanks to higher margins, EBITDA has been compounded at 8.6% per year.
- Net income has grown by more than 9% per year.
In the most recent 1Q24 quarter, the company continued its growth, showing 7% revenue growth and 12% growth in adjusted EPS.
According to the company, the first quarter saw a solid start in Employer Services and new business bookings.
Notable performers included the small business portfolio and compliance-oriented solutions. HCM demand remained steady, with a healthy new business pipeline.
Retention rates exceeded expectations, and NPS scores reached an all-time high.
Furthermore, during the quarter, ADP's suite of workforce management solutions reached over 125,000 clients. Retirement services clients surpassed 150,000, reflecting over 20% growth since fiscal 2022.
As a result, the company maintained its full-year 2024 outlook, with total revenue growth of 7% to 8%. This could lead to at least 10% annual EPS growth.
The good news is that ADP sees a path to sustainable long-term growth.
As discussed during this year's TD Cowen Human Capital Management Summit in November, the company highlighted a number of favorable trends that are expected to provide the company with long-term growth opportunities.
For example, the company describes the demand environment as healthy in the U.S. SMB market. Small businesses continue to be a significant driver of bookings growth. There haven't been discernible changes in lead volumes or sales cycles, and the sales force's tenure is improving.
Furthermore, the retirement services business has over 150,000 clients, with revenue in the hundreds of millions of dollars.
It's outpacing growth in other ADP businesses. The company sees a significant opportunity to address the retirement plan gap in the U.S., and legislative incentives like the SECURE Act 2.0 provide tailwinds.
According to Fidelity :
The law builds on earlier legislation that increased the age at which retirees must take required minimum distributions (RMDs) and allowed workplace saving plans to offer annuities, capping years of discussions aimed at bolstering retirement savings through employer plans and IRAs.
While SECURE 2.0 contains dozens of provisions, the highlights include increasing the age at which retirees must begin taking RMDs from IRA and 401(k) accounts, and changes to the size of catch-up contributions for older workers with workplace plans. Additional changes are meant to help younger people continue saving while paying off student debt, to make it easier to move accounts from employer to employer, and to enable people to save for emergencies within retirement accounts.
The business has a greenfield opportunity, especially in the small business segment, and is well-positioned to capitalize on it.
When the company was asked how it was going to make money from retirement services, here's what it answered :
It’s really three areas.
- The first is the hard dollar fees that are associated with like your normal monthly processing as well as your per participant fee, those are fees to administer the plan.
- The second thing is the participant fees. So that’s fees that you get from the participants. As an example, when somebody goes to take out a 401(k) loan.
- And the third is the revenue from the assets that you have under the administration. So it’s a pretty diverse set of revenue drivers, and it’s ultimately driven by the growth that you have with clients, participants and with assets.
Adding to that, the company's insurance services business, with over 1,000 licensed insurance agents and 200,000 clients, provides workers' comp, business insurance, and health insurance coverage.
The integration with payroll and HR, along with features like the Insurance Inspector, sets it apart in this area.
The company is also implementing new technologies.
For example, GenAI is integrated into the Roll mobile app, providing AI-driven payroll assistance.
ADP is actively exploring GenAI's applications in transcribing call recordings, suggesting responses in chat interactions, and enhancing product search functionality.
In general, ADP embraces evolving buyer expectations, leveraging digital sales and self-onboarding capabilities.
About one-third of new clients fully onboard themselves. So far, the emphasis on self-service capabilities has contributed to a 20% reduction in service contact.
One benefit that comes with a wide variety of services is upselling.
The company is strategically focused on upselling additional solutions to existing clients, particularly in the small business segment.
This also allows the company to capitalize on opportunities for global growth, especially in international markets.
The company has a stronger focus on modernizing platforms globally, leveraging multinational solutions, and accelerating growth through strategic initiatives.
The ADP Dividend
On top of a strong business model, ADP has rewarded its investors with 49 consecutive years of dividend growth. This means it's just one year away from becoming a dividend king.
Even better, unlike some dividend kings, the company isn't suffering from slow growth, as we already established. It's a company that combines consistency with elevated dividend growth.
Looking at the Seeking Alpha dividend scorecard below, we see that the company has top scores for dividend safety and consistency. It has a high score for growth and a B- for dividend yield.
Dividend safety is underlined by a sub-60% payout ratio and a net leverage ratio of less than 0.2x EBITDA. As I already briefly mentioned, the company has an AA- credit rating. That's one of the highest credit ratings in the world.
Even better, the 2.4% dividend yield comes with a five-year dividend CAGR of 13.6%, which even beats a lot of much younger dividend growth companies.
On November 8, the company hiked its dividend by 12% to $1.40 per share per quarter.
On a side note, the company's dividend growth history looks like something out of a textbook. I have rarely seen a dividend history chart that looks this good:
So, what about the valuation?
Valuation
Good things rarely come cheaply. As we can see in the chart below, the last time ADP was "cheap" was between the Great Financial Crisis and 2013, when it took the market multiple years to award the stock a multiple worthy of its growth potential.
Unfortunately, we cannot go back in time.
Nonetheless, it could be a lot worse.
Using the data in the chart below:
- ADP is currently trading at a blended P/E ratio of 26.9x.
- The normalized P/E ratio going back twenty years is 24.9x.
- This year, EPS is expected to grow by 11%, which is in line with company guidance.
- Next year, EPS is expected to grow by 10%, followed by 9% growth in the 2026 fiscal year.
- These growth numbers warrant the company's 24.9x normalized long-term multiple.
- When incorporating its dividend, expected EPS growth, and a return to a sub-25x EPS multiple, the company could return 9% per year through its 2026 fiscal year.
However, if the company were to keep its current valuation, it could return more than 14% per year.
That is not impossible if it is able to show the market that its growth initiatives are able to maintain annual EPS growth of close to 10%.
The current consensus price target is $241, which is 4% above the current price.
Unfortunately, as the chart above shows, the stock has rallied more than 10% from its November lows.
I will give the stock a Buy rating, but I do not suggest that investors go all-in at these prices.
Given that we're dealing with ongoing economic risks and a recent stock price rally, I believe that gradual buying is the way to go here.
If the stock drops, investors can average down. If it suddenly takes off, investors have a foot in the door.
This is how I currently deal with all of my investments.
On a long-term basis, I have little doubt that ADP has the potential to keep outperforming the market with a favorable volatility profile, consistent dividend growth, and very low financial risks.
Takeaway
Automatic Data Processing emerges as the epitome of dividend investing's holy grail. Boasting a 49-year dividend growth streak, ADP combines a strong business model, consistent growth, and a 2.4% dividend yield.
Its robust performance, beating the S&P 500, stems from a proven business strategy in human capital management.
The company's expansion into global markets, combined with a focus on modernization and strategic initiatives, positions it for sustainable growth.
While not currently a bargain, ADP's potential to return over 14% annually, coupled with prudent buying strategies, makes it a compelling choice for investors.
For further details see:
Dividend Investors Take Note: Automatic Data Processing Has It All!