2023-10-03 06:37:41 ET
Summary
- Paycom's total revenue for 2Q23 was $401 million, up 26% YoY, exceeding expectations.
- The company's cash flow profile is strong, with $536.5 million in cash and $29 million in total debt.
- I expect PAYC to continue growing at a rate of over 20% and believe it has expanded its market opportunity globally.
Summary
Readers may find my previous coverage via this link . My previous rating was a buy, as I believed Paycom ( PAYC ) would continue to displace incumbents in the payroll industry. I expect PAYC to continue winning due to its single point of contact and quick response times, compared with those of service bureaus such as Automatic Data Processing ( ADP ). I am reiterating my buy rating as I believe the business fundamentals remain strong and the valuation has reverted down to a level where it should be the trough.
Financials / Valuation
PAYC's total revenue for 2Q23 was $401 million, up 26% year over year and ahead of expectations. If interest income is factored in, however, it would appear that recurring revenue grew at a slower rate (interest rates continue to rise, which leads to higher interest income), so this must be taken into account to ensure a more accurate comparison. Adj. EBITDA of $156.6 mn, implying 39% margin, came on the heels of the 26% growth and was also higher than the consensus estimate of 38.5% margin. At the end of the second quarter, PAYC had $536.5 million in cash and $29 million in total debt on the balance sheet. I estimate that free cash flow was around $60 million, for a margin of around 15%. This means that the company's cash flow profile is still very strong and healthy.
Based on author's own math
Based on my view of the business, PAYC should be able to continue growing at >20%, which is the current momentum it is expected to grow. Note that management guided for 25% growth in FY23 as well. I remain modest with my margin assumptions, assuming a flattish trajectory in the next 2 years as I expect interest rates to revert back to a more normal level, which will hurt gross margin, offsetting any positive margin movements as revenue scales. As I commented below, a big reason for the share price to collapse was due to expectations running high (PAYC traded at 30+ PE previously when I wrote about it). However, at the current valuation, it is now trading at a discount to peers (at 35x forward PE), which I believe is not warranted as PAYC is expected to grow at the same rate (20+%), has much higher EBITDA margins (35% vs. peers’ 6%), and has virtually no debt (peers have an average debt-to-equity ratio of 47%).
- Bill holdings
- Paycor
- Ceridian
- Workday
- Paylocity
- Automatic Data Processing
As such, I believe the current 29x forward PE that PAYC is trading at should be the trough. Using 29x forward PE in my model, I see an upside of 21% from here.
Comments
Before I go into my outlook, I thought it was fair to comment about stock price performance so far. In my previous update, I had a target price of $403 when the stock was at $322, indicating a 25% upside. Both the business and stock moved in the right direction as predicted; however, the stock fell by a big margin post the 2Q results, which I thought was unfair as it was due to expectations running too hot (PAYC is not beating consensus by as much as it did historically). Over the past 16 quarters, PAYC has beaten consensus by at least a mid-single-digit percentage, but that figure dropped to just 1.6% in 2Q23. As I do not believe there are any fundamental flaws in the company, I reiterate my bullish recommendation.
I expect PAYC to continue growing at the current high rate of at least 20% as it continues to displace incumbents. It appears from 2Q23 results that PAYC is gaining traction in the up-market (comprises companies with >10k employees) with BETI. Management also claims to have closed larger deals with values between $2 and $3 million in the quarter. My attention was fixed on BETI's achievements, as management disclosed that over 40% of its client base is not yet using Beti, indicating substantial room for long-term incremental upsell. With the fact that BEIT is able to yield a 90% reduction in labor for payroll processing through its self-service solution, I believe it will continue to gain positive traction. Especially in the current competitive environment where businesses are going for automation, I believe BETI has a very strong value proposition. Aside from traction with BETI, PAYC also continues to extend its reach outside of the US. On the call, management announced that the company's global HCM software is now available in more than 180 countries, with self-service payroll now available to employees in Canada. With this extension, the growth runway for PAYC is now significantly extended, as it only has 5% of the market share today.
“With our new expanded market opportunity, we now estimate our market share is well below 5%. This expansion gives me confidence that we can grow at an impressive pace for many years to come. In addition to launching our payroll services in Canada, our product development team also rolled out two significant tools in our software, Everyday and the Client Action Center.” Source: 2Q23 earnings
From a business standpoint, PAYC's ability to continuously expand its product range, such as with the introduction of the Everyday module (expected to be monetized), remains a consistent source of growth for the company. In this instance, the Everyday module enables users to receive daily payments without incurring transaction fees, presenting a substantial value proposition in my opinion. Additionally, PAYC has unveiled the Client Action Center, a dashboard integrated into the Paycom mobile app that allows customers to take actions and stay updated on service-related matters. The company's commitment to organic innovation continues to impress me, and that's especially true in light of the fact that I think the Beti product is still a major differentiator in the industry.
Net-net, I am constructive on PAYC's performance (despite the share price drop) and continue to see Paycom well positioned to continue growing.
Risk & conclusion
PAYC is expanding thanks to the interest it receives on customers' deposits, which is benefiting from the current low interest rate environment. Depending on how quickly interest rates normalize, this could have significant consequences for the company performance in the short-term.
In conclusion, I maintain my buy rating on PAYC as the company's strong fundamentals and recent valuation adjustment present an attractive opportunity. PAYC's 2Q23 results exceeded expectations, with robust revenue and margin performance. The company's cash flow profile remains healthy, with ample cash reserves and limited debt. I anticipate continued growth at a rate of over 20%, driven by PAYC's ability to displace incumbents and gain traction in the up-market segment with its BETI product. The expansion of product offerings, including the Everyday module and the Client Action Center, further supports its growth trajectory. While market expectations may have cooled, I believe PAYC's long-term potential remains compelling, especially with its global expansion efforts.
For further details see:
Paycom Software: Fundamentals Remain Strong, Reiterate Buy