2023-06-21 09:46:47 ET
Summary
- Paycor HCM stock is showing signs of bottoming out and remains undervalued, with strong business fundamentals and growth momentum.
- The company's robust metrics, customer growth, and potential use of AI in its operations provide confidence in its resilience despite concerns about a potential recession.
- Risks related to the macro environment and its impact on employment should be considered.
Summary
Previously, I noted that a combination of a robust economy, a growing number of available jobs, and Paycor HCM's ( PYCR ) dedication to ongoing product improvement provide the company with a strong growth runway. PYCR stock has finally shown signs of bottoming as the share price rose back up from the low $20s. While the share price has not reacted positively since my initiation , I continue to see the stock as undervalued today as the business fundamentals continue to perform better than I expected. The recent quarter was indicative of this as PYCR beat on its 3Q23 guidance and raised FY23 guidance, showcasing the ongoing momentum and management confidence for FY23 – which I take it as a sign that management is confident about CY23 as well (note PYCR FY ends in June). Supporting this growth trend is the strong tailwinds that the business is enjoying, including stable employment trends and strong performance in Tier 1 regions. At 6.2x forward revenue and a slightly higher revenue base in FY23, the upside remains appealing to me.
Growth expectations
I believe the broad concern about the pending recession and how it would impact PYCR might be overblown at this point as all the underlying metrics remain strong. For instance, the number of customers has risen above 30k , which indicates that the average monthly recurring revenue is still increasing by the high teens. In addition, the average number of employees per customer rose to 79 from 75 a year ago and 78 sequentially, showing the continued success of the upmarket shift. Importantly, I think there is still several room for Per Employee Per Month (PEPM) to increase even at the current $44 (which has already risen a lot from the $27 level in FY19).
Management hopes to achieve $50 PEPM by 2024, and considers the target price to be a floor rather than a ceiling; the company plans to continue its trajectory of steadily increasing its PEPM list price by introducing new features and product lines. The fact that PYCR has been able to steadily move up market, where customers typically buy more modules than smaller customers, gives me confidence that it can hit that target. Bookings were also reported to be at an all-time high, with management citing a consistent mix as the reason. When looking at qualitative factors, I believe the Talent module has been consistently strong and will eventually replace the Workforce Management module. I believe that many companies have reduced their workforces as a result of the weak macro environment. It is crucial for these companies to have a competent staff in place to guarantee business as usual. So, I anticipate that the Talent solution will grow in prominence as a result of the growing recognition that it is crucial for business owners to hire the right people.
Generative AI opportunity
Being a software company with a large amount of incoming and outgoing data makes me confident that PYCR can make good use of AI to boost its operations. PCYR, for one, could use generative AI to develop and enhance services like sentiment analysis, churn prediction, and automated job postings. In addition, I think PYCR can use its existing HR expertise to its advantage by creating a chatbot to assist with customer solution development and deployment. Internally, the first department I expect management to leverage AI is the client service call center, which can be optimized easily using chatbots in my opinion.
Valuation
Despite trading at $23, PYCR stock is deemed undervalued based on my assessment. To account for the uncertainty in the macro environment, I revised my model to reflect the updated FY23 guidance and adjusted assumptions for FY24/FY25 (assuming 20% growth). The strong growth momentum indicated by the operating metrics leads me to believe that achieving 20% growth is feasible. Furthermore, I anticipate a potential rerating of the valuation, currently at 6x forward revenue, once the broader market's "risk-off" sentiment subsides following the resolution of the macro turmoil. If we compare PYCR to Paycom ( PAYC ), PYCR trades at a discount, which I believe is because it is not profitable today. However, both companies grow at similar rates. Once PYCR starts to print positive net profit (consensus expects positive net income in FY23), I think the market will start to re-rate multiples upwards to close the gap (once the macro turns better).
Author's Model
Risks
Employment data and management comments so far indicate that hiring has slowed but not stopped. Nonetheless, I do not discount the possibility of a recession, especially for the smaller businesses that make up the lower end of Paycor's target 10-1,000 employee target segment. In a major recession, the number of employees that will be on payroll will be lesser as businesses cut headcounts, this directly impacts the number of “volume” that PYCR will process. Which in turn could be a direct hit to its financials.
Conclusion
PYCR stock shows signs of bottoming out and remains undervalued at its current price of $23. The business fundamentals continue to outperform expectations, as evident from PYCR's beat on 3Q23 guidance and raised FY23 guidance. While concerns about a potential recession persist, PYCR's robust metrics and customer growth provide confidence in its resilience. However, risks related to the macro environment and its impact on employment should be considered.
For further details see:
Paycor HCM: Valuation Is Still Not Reflecting The Improving Fundamentals