3 payroll companies get clocked, but 1 looks cheap

Key Points

• ADP is the oldest and largest payroll company, selling at a historically cheap valuation, but a peak interest rate will result in lower interest income moving forward.
• Paychex accommodates small to medium-sized businesses for its payroll and HR management services, growing at a modest 6.6% YoY revenue growth rate but earning $32.7 million in interest income from holding client funds for payroll.
• Paycom Software created an automated solution called Beti that enables employees to process their payroll. It has been so popular that it's been cannibalizing sales from its core payroll processing services.

Payroll companies alleviate the complexities of processing payrolls. They withhold taxes, apply payments to various government agencies, track employee hours, track benefits, comply with regulations, and calculate and process employee paychecks. They can also provide value-added human resources services like employee onboarding, performance management and termination.

Additional services can include retirement planning, administration of worker's compensation programs, employee counseling and even talent acquisition. Payroll companies receive recurring revenues and generate more revenues for more services. They also collect additional interest income from holding customer funds for payroll. Despite the strong jobs market, payroll companies have recently seen their stocks plummet. Valuations have come down, but one provides more value than the others.

Automatic Data Processing Inc. NYSE: ADP

ADP provides cloud-based human capital management solutions worldwide. They are a mature business that's been around since 1949. Segments are divided into Employer Services and Professional Employer Organization. Its solutions unify HR, payroll, tax withholding, benefits, and time-tracking management. ADP is a recognized leader providing analytics and compliance expertise. Due to their enormous size and access to employment data, they release their own jobs report preceding the U.S. Bureau of Labor Statistics (BLS) jobs report monthly. The company has implemented generational artificial intelligence (AI) into Agent Assist and Roll, a chat-based payroll app.  

Steady growth

ADP reported fiscal Q1 2024 EPS of $2.08, beating analyst estimates for $2.02 by 6 cents. Revenues grew 7% YoY to $4.51 billion versus $4.52 billion analyst estimates.

Reaffirmed guidance

ADP reaffirmed fiscal full-year 2024 adjusted diluted EPS guidance of 10% to 12% EPS growth or $9.05 to $9.22 versus $9.14 analyst estimates. Full-year 2024 revenues are expected to grow 6% to 7% between $19.09 billion and $19.27 billion versus $19.19 billion consensus analyst estimates. Adjusted EBIT margin expansion of 60 to 80 bps is expected.

Lower taxes and higher interest rates helped juice profits.

ADP benefited from the 160 bps drop in tax rate to 21.3%. Since its clients have to deposit funds for ADP to disperse payrolls every two weeks, the company benefits from higher interest rates. This will drop with rate cuts but won't improve as the Fed signaled it may be done with interest rate hikes.

ADP CEO Maria Black commented, "Our" workforce management solutions, sometimes called time and labor management, reached more than 125,000 clients in the first quarter, benefiting from a double-digit growth rate these last few years. Scheduling and precisely tracking time has become more important for employers over recent years to meet evolving legislative requirements, and we look forward to continuing to invest in our workforce management solutions to drive higher client attach rates."

ADP analyst ratings and price targets are at MarketBeat. ADP peers and competitor stocks can be found with the MarketBeat stock screener.

Weekly rounding bottom

The weekly candlestick chart on ADP shows the aftermath of the rounding bottom pattern. ADP shares peaked at $255.56 and then collapsed to a low of $205.53 on its earnings release. Shares returned to $222.46 as the weekly relative strength index (RSI) coiled back up through the 40-band. Pullback support levels are $211.76, $205.53, $192.26 and $182.32. A breakdown through $200 can take shares as low as $160. ADP is trading 24X forward earnings with a 2.28% annual dividend rate.

Paycom Software Inc. NYSE: PAYC

Paycom can be considered a disruptor in the industry. They developed an automated solution called Beti, which enables employees to manage their payrolls. The service has been so popular that it's cannibalized Paycom's core payroll services. This resulted in weaker Q3 2023 earnings results, and a sharp guidance cut, which prompted shares to collapse by over 100 points or 39%. While adoption is going well, many older customers have no wish to switch or change services, which is causing some uncertainty and volatility in its lowered forward guidance. Paycom has the highest growth rate of the three payroll companies due to its much smaller revenue, leaving more room for scaling up.

Growth concerns

Paycom reported Q3 2023 EPS of $1.77, beating analyst estimates for $1.61 by 16 cents. Revenues climbed 21.6% YoY to $406.3 million, falling short of $411.76 million. Adjusted EBITDA was $165.6 million compared to $126 million in the year-ago period. The company has nearly $500 million in cash, no debt and is still projecting a double-digit growth rate.

Beti cannibalism prompts lowered guidance.

Paycom lowered its Q4 2023 revenue guidance to $420 million to $425 million versus $452.28 consensus analyst estimates. The revenue growth rate was cut down to 14%, down from the 27% growth it exhibited in the preceding five quarters. Paycom CEO Craig Boetle commented, "Now that more clients are achieving the ROI that Beti has to offer, it has eliminated certain billable items, cannibalizing a portion of our services and unscheduled revenues."

Analyst actions

Paycom earnings spurned many analysts to take action, as Citi, KeyBanc, Needham, and Deutsche Bank all downgraded shares of PAYC. Deutsche Bank analyst Bhavin Shah said, "Beti is leading customers to spend less on services and unscheduled payroll runs, negatively impacting monetization opportunities for Paycom. We struggle to see how Beti adoption will not be deflationary for an indeterminate period of time."

Paycom analyst ratings and price targets are at MarketBeat.

Weekly head and shoulders breakdown

PAYC shares formed a weekly head and shoulders pattern with a falling neckline. The left shoulder peaked at $469.83, the head peaked at $557.48, and the right shoulder peaked at $401.71 ahead of the neckline breakdown at $204.87. PAYC collapsed to a post-earnings swing low of $146.15. The weekly RSI cratered under the 30-band level. Pullback supports are at $146.16, $122.81, $96.18 and $83.18. PAYC is trading at 26.11X forward earnings with no dividend.

Paychex Inc. NASDAQ: PAYX

Paychex provides human capital management services, including payroll, benefits, and insurance services, to small and medium-sized businesses (SMBs). Paychex has indicated that SMBs have been resilient despite the macroeconomic uncertainty. SMBs are still hiring at moderate levels, and wage inflation is moderating, but accessing capital and managing cash flows are challenging. The company has a strong balance sheet with no long-term debt. The company also benefits from higher interest rates holding cash balances, as indicated by the 83% growth in interest income for the year-ago period. 

Cash flowing

Paychex reported fiscal Q1 2024 EPS of $1.14 versus the $1.12 analyst expectation, a 2-cent beat. Revenues climbed 6.6% YoY to $1.29 billion, beating $1.28 billion analyst estimates. The company earned $32.7 million in interest on client funds, up 83% from $17.9 million in the year-ago period. The company closed the quarter with $1.65 billion in cash and cash equivalents.

Slightly raised guidance

Paychex provided fiscal full year 2024 EPS guidance of $4.65 to $4.74 or 9% to 11%, up from 9% to 10% previous guidance, versus $4.68 consensus analyst estimates. Fiscal full-year 2024 revenues are expected to grow 6% to 7% or $5.31 billion to $5.36 billion versus $5.33 billion consensus analyst estimates. Paychex also expects to collect $135 million to $145 million in interest income from the holding client funds.

Paychex CEO John Gibson commented, "Demand for our solutions remains strong as businesses continue to look to us for the technology and expertise to navigate today's rapidly changing business environment. In addition, by harnessing the power of Artificial Intelligence and leveraging our vast data sets, we deliver more actionable insights to our clients, helping them make informed decisions on how to address today's growing workforce and compliance challenges."

Paychex analyst ratings and price targets are at MarketBeat.

Weekly descending triangle pattern

The weekly candlestick chart on PAYX illustrates a descending triangle pattern. The descending trendline formed in July 2023 after peaking at $128.77. Shares steadily fell with lower highs on each bounce, reaching flat-bottom support at $106.27 in late October 2023. The weekly RSI stalled at the 40-band. The weekly MSL triggers a breakout through $117.68. Pullback support levels are $106.27, $101.04, $95.91 and $90.62.