2023-07-05 05:27:37 ET
Summary
- Paycom exhibits stable revenue growth rates of around 30% and is expected to maintain mid-20s% growth in 2023.
- Paycom has a strong profitability profile, boasting of high EBITDA margins of 42% and low stock-based compensation, indicating shareholder alignment.
- Paycom recently initiated a dividend, reflecting its confidence in its financial strength and growth prospects, while still pursuing opportunities for expansion.
- A stock that's worthwhile considering.
Investment Thesis
Paycom ( PAYC ) is a human capital management software company.
The crown jewel of the bull case is that management is highly aligned with its shareholders. I'll explain more about this soon.
The key takeaway here is that Paycom is growing at a fair rate and I believe is really attractively priced at 38x next year's free cash flows. Note, on the surface, this might sound like a stretched valuation, but I must impress upon readers that these free cash flows are very clean.
All in all, I believe this is an exciting opportunity at around $19 billion market cap.
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.
If readers know Workday ( WDAY ), Paycom is somewhat similar to that, but Paycom is more focused on smaller and mid-sized businesses. Another notable difference is that Paycom's platform is more focused on being easy to implement and is slightly less customizable than its bigger peer, Workday.
Moving on, in the past 3 years, the performance of both companies has been relatively similar. However, in the past 12 months, their performance has been very different, with Workday easily outpacing Paycom and leaving Paycom behind.
And I don't believe this is entirely justified.
Revenue Growth Rates Are Very Stable
As you can see above, Paycom's growth rates have been very stable at around 30%. Yes, its guidance for 2023 sees its revenue growth rates dropping slightly to the mid-20s% rather than 30% CAGR, but a portion of that slowdown is also likely to be due to management's conservative guidance.
And now, let's get to the top reason to consider this stock.
Profitability Profile is the Crown Jewel
Paycom has a very strong balance sheet. Case in point, even after adjusting for its debt, I suspect that Paycom will finish Q2 2023 with around $500 million of net cash.
What's more, the business is clearly generating more than enough free cash flows, which we'll soon discuss.
Indeed, given its strong balance sheet and free cash flow profile, Paycom believes that it is in a good position to initiate its first dividend. This makes Paycom a rare company that is not only growing rapidly but also paying out a dividend. Admittedly, Paycom's dividend is more symbolic than anything, but it's better to have it than not to have it.
Moving on, Paycom finished 2022 with 42% EBITDA margins. Meanwhile, its guidance for 2023 also points to 42% EBITDA margins. And now onto the real shocker, Paycom's stock-based compensation only makes up around 10% of its EBITDA figure. If you follow enough companies, you'll have two immediate reactions to this comment.
At first, you'll doubt yourself and double-check the fact that the vast majority of its EBITDA is not made up of stock-based compensation . Followed rapidly by a second insight, that the company must have a large amount of insider ownership.
And indeed, as the table above demonstrates, Paycom's founder and CEO Chad Richison holds nearly 14% of the nearly $19 billion market cap company. Put another way, Richison is in a very close alignment with its shareholders.
Accordingly, the more profitable the company becomes, the more excess free cash flow there will be available for raising its future dividend and other capital return considerations.
Moving on, in 2022, about 40% of Paycom's EBITDA turned into free cash flow. If we were to presume a similar conversion in 2023, this would mean that Paycom's free cash flow this year would reach around $290 million. This figure is approximately 25% higher than in 2022.
And by extension, if we conservatively estimated that in 2024, Paycom's free cash flows would grow at a slightly more moderate pace of 20%, this would see Paycom's free cash flows reach close to $500 million.
This means that looking out to 2024, Paycom is priced at about 38x forward free cash flows. And figure that is less expensive than it may seem, given that its revenues are growing at about 20% to 25% CAGR.
The Bottom Line
Paycom is a human capital management software company. It is often compared to Workday but in recent months its performance has fallen behind that of its peer.
Paycom has shown stable revenue growth rates of around 30% and is expected to continue growing at a mid-20s% rate in 2023. The company has a strong profitability profile, with a healthy balance sheet, high EBITDA margins, and a low percentage of stock-based compensation.
The founder and CEO, Chad Richison, holds a significant stake in the company, aligning his interests with shareholders. Paycom recently initiated a dividend, demonstrating its commitment to returning value to shareholders.
With its growing profitability and expected free cash flows, Paycom stock appears attractively priced at around 38x forward free cash flows, considering its revenue growth rate of 20% to 25% CAGR.
For further details see:
Paycom: Initiated A Dividend, Plus Strong FCF