2023-08-29 14:09:07 ET
Summary
- Paycom Software, Inc. faced a stock drop post Q2 results, but this seems to have created a positive risk-reward opportunity for new investors.
- Investors are becoming cautious about Paycom's slowing revenue growth rates, leading to a sector-wide shift in perception within the HR software industry.
- Despite these challenges, Paycom maintains a strong profitability profile, and its valuation appears to reflect current concerns about growth, making it an intriguing investment prospect.
Investment Thesis
Paycom Software, Inc. ( PAYC ) has seen investors' expectations reset lower post Q2 results . Even though overall the company continues to progress at a rapid rate with attractive cash margins.
If I were to point to just one aspect that dragged down this stock's ascent, it would be that investors didn't take it too kindly that Paycom's revenue growth rates appear to be slowing.
Altogether, I believe that investors have overreacted to its potential slowdown, leaving new investors considering this name with a positive risk-reward opportunity.
Why Paycom? Why Now?
Paycom's platform enables businesses to automate and centralize their HR processes. Paycom provides payroll management, employee self-service, and HR reporting. It's a bit like Workday ( WDAY ), but Paycom is aimed at smaller companies rather than large enterprises like its bigger peer. Furthermore, what it lacks in customization and flexibility it more than makes up with a lower entry point than Workday.
Paycom is an HR and payroll software platform that's aimed at small and medium-sized businesses, or SMBs, with a more narrow scope of products than Workday.
As readers will be aware, PAYC saw its stock drop quite significantly post-Q2 earnings, see below.
However, the fact that PAYC's negative earnings reaction has reverberated through its small-sized peers leads me to conclude that the market is having a change of thought on the underlying value these companies hold.
Put another way, investors are not viewing this sell-off as idiosyncratic to Paycom, but rather something that's capable of affecting the sector as a whole. Put simply, there's a sector rotation afoot.
Investors are becoming increasingly sensitive and cautious that Paycom's revenue growth rates may be decelerating.
Revenue Growth Rates Are Slowing Down
Paycom didn't upwards revise their full-year 2023 revenue outlook. For a growth company, that's never a good sight. This means that what we see is very much all there is, with Paycom's revenue growth rates stabilizing in the low 20s% CAGR.
Indeed, during the Q&A section of the earnings call , this is precisely what an analyst put forward to management,
If I think about recurring revenue, and I take out, but the impact of higher rates and the and the average flow balance, it kind of suggests maybe, like, a 20% to 22% or let's call it low-20s like, software revenue growth rate going forward.
Management didn't deny this line of reasoning, and instead, they remarked what everyone already knew, that Q2, the quarter just passed, saw Paycom's growth deliver strong results.
Nevertheless, pointing back to what a company has already delivered is never something investors welcome. What investors are always attempting to ascertain is what the next 6 months look like for the company.
And if a company goes from a period where it could be relied on to deliver a high 20s% to 30% CAGR, and now can only be counted on for low-20s% CAGR , as investors attempt to formulate a view of 2024, investors now have to come to terms with a slightly slower growing Paycom than they previously expected prior to these Q2 results.
Strong Cash Flows, Still the Bull Case for Paycom
In my previous analysis , I stated that Paycom's bull case was found in its strong profitability profile. I made the argument then, and stand by it now, that when one invests alongside a management team that has a lot of skin in the game, management is highly motivated to operate the company with an eye toward profitability.
Case in point, during the earnings call management reiterated that Paycom has what it takes to operate as a Rule of 67. Meaning that its EBITDA profitability together with its growth rates add up to 67%. Recall, that anything higher than 40% is typically viewed as a highly attractive company that warrants a high premium on its stock.
Moreover, as you can see above, during 2023 Paycom has mostly been priced at around 9x to 10x forward sales, but through a temporary multiple expansion, Paycom was rewarded with a higher multiple, at close to 12x forward sales.
But for all intents and purposes, its multiple remains in line with its recent average. This means that investors are already pricing in a considerable amount of negativity plus the expectation of a slowdown in its growth profile.
The Bottom Line
Paycom Software recently faced a stock drop due to concerns about slowing revenue growth rates. While the market's reaction may seem negative, it has created a potentially positive risk-reward opportunity for new investors. Paycom offers a platform for automating and centralizing HR processes, primarily targeting small to medium-sized businesses. Although it lacks the customization of larger peers like Workday, it compensates with a more accessible entry point for customers.
Investors' sensitivity to Paycom's decelerating revenue growth rates has led to a sector-wide shift in perception. While the company didn't revise its full-year 2023 revenue outlook upwards, it still maintains a strong profitability profile, with the Rule of 67 concept highlighting its EBITDA profitability and growth potential. Paycom's current valuation remains consistent with historical averages, suggesting that investors may have already priced in concerns about growth. Overall, despite short-term challenges, Paycom's long-term prospects and financial strength offer an attractive investment proposition.
For further details see:
Paycom: A Positive Opportunity After Q2