Paychex Cashes In On Economic Reopening

Paychex Is Levered For Success

Paychex NASDAQ: PAYX has been on our radar as a reopening play since the middle of last year. The entire labor market experienced a contraction that for labor market companies wasn’t nearly half as bad as it could have been. While the level of business per client shrank due to closures, social distancing, and economic slowdown, the number of clients increased. What this means for Paychex and for all of the labor market stocks is a lever for growth. Paychex is already operating above its pre-pandemic level and growth should accelerate into the end of the year as economic momentum gains strength.

Paychex Returns To Growth

Paychex, a payroll and human resources services company focused on smaller businesses, had a great quarter and one supported by widespread economic reopening. The company's revenue of $1.03 billion is up 12.6% from last year and beat the consensus by 500 basis points. The revenue is a sequential slowdown but that was seasonally expected and offset by the fact the company produced its first year-over-year growth in 5 quarters, and that revenue is up 5% in the two-year comparison.

Services, the company's core operating segment, increase 14% but was offset by a 43% decline in interest earnings from funds held for clients. In terms of the net, interest earnings from funds held for clients is about 1.5% of total revenue. Within the services segment, Management Solutions grew 14% to account for roughly three-quarters of all revenue while the Professional Employee Organization grew 13% to account for about 25% of all revenue.

Moving down the report, margins widened as well. Company expenses grew by only 10% compared to revenues 12.6% gain and led to an 18% increase in operating income. On the bottom line, the GAAP EPS grew 20% from last year to $0.73 and beat the consensus by $0.06 while the adjusted earnings grew 18% to $0.72 and beat by a nickel.

Paychex Delivers Value For Dividend Growth Investors

Paychex puts its earnings to good use by buying back shares and paying a dividend.  The company bought back 1.7 million shares over the past year for a total of $155.7 million and is on track to buy back shares again this year. The dividend is worth about 2.5% in yield and comes with a high expectation for dividend increases. The company has been increasing the dividend for the last seven years at a 10% CAGR so we are expecting a double-digit increase again. The only caveat is the 80% payout ratio but even that is not as bad as it looks. The company has very low levels of debt, high levels of cash, a leverage ratio below 1X turnings, and oodles of free cash flow. The company just issued its distribution increase last quarter so it will be at least six months before the next one comes. 

The Analysts Are Cashing In On Paychex

At least five major sell-side analysts have come out with a positive update on Paychex since the fiscal Q4 earnings release. They've all maintained a buy or better rating and included a price target increase as well. The consensus of these five has the stock trading in the range of $107 which is only fairly valued compared to current price action. The high price target is $115, however, and we expect to see more upward pressure on the consensus.

Shares of the stock broke out to a new all-time high in the wake of the report and look set to continue trending higher. Based on the trend, and the bullish signal in the indicators, we think this stock could easily hit the $115 level if not go higher. Assuming the economic rebound continues to unfold the way that we think it will, and that and unemployment continues to fall, this stock should beat its consensus estimates for the next quarter as well.