2023-06-15 23:39:02 ET
Summary
- Paychex leverages its technology, Paychex Flex, to provide human capital management solutions to small and medium-sized businesses, driving strong demand and growth.
- PAYX has reported increased revenues and maintains a strong financial position with low leverage risk and strong cash flows.
- However, Paychex is currently overvalued compared to its peers, making it advisable for potential investors to wait for a cheaper entry point and for current investors to hold for its peak.
Investment Thesis
Paychex, Inc. ( PAYX ) provides small and medium-sized businesses with solutions related to human capital management [HCM], including human resources, insurance, benefits, and payroll services, in India, Europe, and the United States.
Over the last twelve months, its share price has plunged by about 5.05%; however, it has still managed to maintain its strong financial performance. Paychex has been leveraging its technology, Paychex Flex, to offer its services and solutions better. This technology has, in turn, contributed to the strong demand for its solutions. These variables, I believe, are crucial in driving the company's growth as well as its performance.
PAYX has reported increasing revenues in both the most recent quarter and for the nine months of the fiscal year 2023. Moreover, it is in a solid financial position due to its strong balance sheet with very low leverage risk as well as its strong cash flows. However, the company is trading at a higher price than its peers, making it overvalued.
Leveraging Technology
Paychex Flex technology is the company's all-in-one HCM-focused software that helps small and medium-sized companies. The technology streamlines payroll, workforce, talent management, and benefits. Through this technology, the company has smoothly provided the solutions it offers to its clients.
First, Paychex retention insights is a predictive analytic model that utilizes vast records of employment data. These projective insights help clients identify employees with a higher chance of leaving a company. This model is available on the Paychex Flex platform, whereby Paychex Flex clients can identify potential risk factors through their access to live and interactive reports. Identifying these risk factors predicts an employee's likelihood of resigning.
PAYX utilizes Paychex Flex Hiring and Onboarding, which are features in Paychex Flex that provide hiring solutions to its customers. Paychex Flex Hiring has simplified the hiring process through automated tasks and actions, enabling clients to recruit new employees efficiently. This feature has helped clients with different recruitment methods, from job posting to sending high-potential candidates offer letters digitally.
The company has also smoothed its clients' onboarding processes for its new hires through Paychex Flex Onboarding . The feature has helped recruits with the completion of necessary paperwork by providing online forms and allowing laptop and mobile access to complete them. Clients can also view and track their new hires progress as they continue onboarding. The technology has provided a seamless and paperless process for Paychex's clients and their new hires.
These are just a few services and solutions Paychex offers that leverage its technology. These enhancements in the Paychex Flex technology have provided clients with a range of self-service options and enhanced both the clients and their employees' experiences.
Resilient Demand
The global HR consulting market has been anticipated to grow at an annual rate of 5.0% from 2022 to 2032. Rising demand, especially from small businesses, is an expected driver of this market's growth.
Paychex has been witnessing stable demand for its solutions. Particularly demand for its HR solutions and services, including Paychex Professional Employer Organization [PEO], HR consulting, and hiring services. It has also seen increased demand for its retirement and time and attendance solutions, where the latter uses Paychex Flex Time, a cloud-based time and attendance system. Additionally, demand for its ERTC service has also remained strong. As a result of this service, businesses have utilized capital from their tax credits to reinvest in other solutions provided by the company.
The effect of this demand is reflected in PAYX's revenues, particularly in the management solutions business, which increased to $1 billion, up 7% from the same period the previous year. This is a result of the increased number of worksite employees for the company's HR solutions and higher revenue from each client, partly due to increased demand. This demand trend is expected to continue; however, although the company expects the demand for ERTC service to continue well into the next fiscal year, it also expects it to moderate as the year progresses.
Financial Performance
For the nine months that ended in fiscal year 2023, total revenue was up 9% from the previous year's period to $3.78 billion. Zooming in on the MRQ, total revenue was $1.38 billion, up 8% from the year-ago period. This was a revenue surprise that beat the estimates by $332.28 million. Management solutions business increased to $1 billion, a 7% increase, and PEO and insurance solutions increased 6% to $321.2 million. This revenue growth was driven partially by strong demand, as mentioned earlier. Other factors contributing to this performance were pricing, growing human capital management services, and growth in the average number of worksite employees. The company's expected revenue growth rate remains unchanged (8%) at the end of fiscal year 2023.
Looking at the EPS in the most recent quarter, PAYX had an EPS of $1.29, an 8% increase from last year's same period. The reported EPS beat the consensus estimate by $0.04. The company anticipates EPS to grow between 13% and 14% at the end of fiscal year 2023.
How strong are the balance sheet and cash flows?
Over the trailing twelve months, Paychex has recorded a cash balance of $1.56 billion, a 27% increase from the past year. Its total debt is currently at $871.2 million, a decrease from the previous year's $906.3 million. Its operating expenses of $1.5 billion result in $52.2 million in net cash, and in addition to that, assuming the company uses its cash to service its debt, its net cash would be $739.8 million. A total equity of $3.4 billion brings its debt-to-equity ratio to 25.6%, which is significantly low, indicating low leverage. Its interest expenses amount to $36.4 million, and with an EBIT of $1.97, interest expenses are covered approximately 54.2x. This clearly shows that Paychex can comfortably take care of its financial obligations.
The company also has $1.63 billion in cash from operating activities, an 8.1% increase from the previous year. Its capital expenditure is down 1.7% to $130.3 million from 132.6 million. This brings the company's free cash flow to $1.497 billion, a 9% increase from the previous year.
As seen above, its free cash flows have been growing. Considering the company's current free cash flows, cash balance, and total debt, I think Paychex is in a strong financial position with very low leverage risk.
Valuation
The company's P/E and P/S GAAP TTM ratios are 26.09 and 8.17, while the sector's average ratios are 19.07 and 1.37, respectively. Paychex's ratios against the sector's average indicate that it is trading at a higher price than its peers in relation to its earnings, making it overvalued. Looking at the underlying metrics, according to Seeking Alpha , its EBIT and EPS diluted y-o-y growth was 9.67% and 10.94%, lower than the sector's average growth of 16.20% and 11.74%, respectively. Further, its revenue growth y-o-y of 9.46% was also outpaced by the sector's average revenue growth of 12.34%. With these growth rates, I don't think they justify the company's pricing. Therefore, I believe potential investors should wait for a cheaper entry point as the current valuation is already a premium price. For the existing investors, considering the company's good financial performance (when looked at in abstract terms but not relative to industry medians), I still see some upside in this company, and therefore I recommend holding for a while for the shares prices to peak at about $125 per share before chasing out profits.
Conclusion
Paychex has been leveraging its technology to continue providing solutions to its customers and has been witnessing a strong demand for its solutions. These factors have driven its performance, and I expect them to continue driving the company's growth. It also reported increasing revenues in the MRQ and the last nine months of this fiscal year. PAYX has strong cash flows and a strong balance sheet with low leverage risk, signaling that it holds a firm financial position. However, despite its performance, the company is relatively expensive. Therefore, I rate it a hold for potential investors for a cheaper entry point and a hold for current investors for the shares to peak.
For further details see:
Paychex: A Hold Despite Strong Performance