2023-11-03 13:00:00 ET
Summary
- Paycom Software's stock has experienced a dramatic collapse after failing to meet the market's growth expectations.
- PAYC's expensive valuation wasn't deserved as its growth cadence continues normalizing. The Beti automation platform's headwinds have hurt its near-term revenue runway.
- However, its valuation has improved with the recent decline, helping to improve its risk/reward profile further.
- I argue why PAYC looks increasingly solid as a buying opportunity for high-conviction investors. An upward reversal to its October highs could provide a 70% potential upside.
This is what happens when the market delivers a harsh dose of reality to a company that's priced for growth but fails to meet forward expectations. Investors in Paycom Software ( PAYC ) have suffered the most significant decline in recent times after the company's third-quarter or FQ3 earnings release.
Accordingly, PAYC collapsed to the $145 support zone in its most recent tumble, registering a decline of more than 60% from its July 2023 highs through this week's lows. On a price-performance basis, PAYC fell nearly 75% from its late 2021 highs, reminding investors about the perils of chasing growth, given its expensive valuation.
Despite the recent collapse, PAYC is still assigned an "F" valuation grade by Seeking Alpha's Quant against its industrial sector ( XLI ) peers. Wait a minute; you might question whether I indicated correctly that PAYC is compared against its XLI peers.
PAYC Vs. peers (1Y total return %) (Seeking Alpha)
It's important to understand that Paycom is classified with its peers listed above within the industrial sector. With PAYC underperforming its peers significantly over the past year, as seen above, it's clear that the market de-rated PAYC downward due to substantial growth fears. Notably, the selloff is not broad-based, suggesting the market has focused on Paycom's structural challenges with monetizing Beti.
What's Beti? Simply put, it's Paycom's solution to help companies automate payroll processing with the key aim of significantly ensuring accuracy. However, the flip side of that value creation is reduced service revenue due to fewer errors encountered. The goal is to reach " perfect payrolls " and "eliminate common after-the-fact payroll corrections, which would otherwise result in billable expenses."
In other words, Paycom is betting that the value created by Beti as new and existing customers adopt the platform could help it gain market share further. Despite that, Paycom management cautioned in its earnings commentary that "the rollout to existing clients has been more nuanced." As a result, management stressed that "it may take time for them to see the value in Beti." In other words, while the adoption of Beli has been robust, it's seeing resistance from existing customers who have yet to adopt the solution. As a result, it's possible that the " resistance to conversion among remaining clients is becoming increasingly structural." While the company highlighted it didn't see a need to change its go-to-market strategy, the execution risks in transitioning its existing customer base to Beti have increased markedly.
Management's guidance for Q3 and initial outlook for 2024 corroborates my observation. Accordingly, Paycom indicated a midpoint revenue guidance of 14% YoY growth for Q4. That's down markedly from Q3's 21.6% growth. It's also down significantly from the average 27% growth over the past five quarters. And that's not all. Management provided a 2024 revenue outlook of between 10% and 12% revenue growth, although formal guidance will be telegraphed along with its Q4 report card.
As such, it's becoming increasingly clear that PAYC's growth cadence is expected to slow dramatically. However, with PAYC down nearly 60% from its July 2023 highs, the critical question that investors must ask is whether the worst has been priced in.
PAYC price chart (monthly) (TradingView)
My early assessment suggests it's possible if buyers can recover the $165 level decisively.
Accordingly, PAYC holders capitulated, as it made an incredible round trip toward its April 2020 lows, re-testing it. However, the price action analysis is based on PAYC's long-term chart, suggesting clarity is only possible at the end of November. Losing this support zone could see PAYC move towards the low $100s zone, resulting in more pain.
With PAYC not considered significantly undervalued, such a move shouldn't be ruled out. However, given the extent of the selloff indicating a capitulation, PAYC's forward EBITDA multiple of 11.3x is below its peers' median of 13.3x. Therefore, I expect to see improved buying sentiment, helping PAYC recover its $165 support level and potentially reigniting a significant mean-reversion opportunity from here. Recovering to its October highs could see a 70% potential upside for buyers willing to catch this falling knife.
Rating: Initiate Buy
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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Paycom: Dramatic Collapse Is A Buying Opportunity - Here's Why