Payroll and human resource (HR) solutions provider Paychex (NASDAQ:PAYX) reported its third-quarter results that beat Street expectations. Revenue and net income grew year over year. The company also raised its fiscal 2014 profit forecast, which is an encouraging sign. Paychex’s fate is closely tied to the employment rate in the U.S., particularly in the small and medium-sized business (SMB) sector. The job scenario in SMB sector is not showing any signs of recovery. But there are other factors that could help Paychex grow in the coming years.
Enough Potential in Payroll Services
Last quarter, Payroll Services revenue, which accounts for 65% of the total revenue, grew 5% due to higher checks per payroll, revenue per check, and an additional processing day during the quarter. Checks per payroll indicate the average number of employees served by Paychex for its clients. Improvement in checks per payroll/client would mean two things — higher employment rate or new business generation. Paychex has been witnessing growth in checks per payroll for more than 15 consecutive quarters. The payroll revenue growth was mostly on account of the surge in new businesses.
Paychex serves the SMB sector that constitutes a major portion of the U.S. economy. Although employment rate is improving in the U.S., job opportunity in the SMB sector is still in the red. But a study made by the company (jointly with business analytics firm IHS) reveals that hiring in the small business sector could go up in 2014, albeit at a slow pace.
Over the years, SMB owners have outsourced their payroll operations to outside vendors for focusing more on the business growth. The payroll service providers are coming up with software solutions for automating payroll processes, making the SMB’s jobs easier. Paychex is also investing heavily to develop new software-as-a-service solutions and applications for mobile devices. Market research firm IDC expects technology spending in the SMB sector to go up significantly, which could be a good opportunity for Paychex. Archrival Automatic Data Processing (NASDAQ:ADP) is also investing heavily to offer advanced solutions and expand its client base.
Further Growth in HR Services Possible
Paychex’s HR Solutions segment makes up for roughly 33% of the total revenue, and offers enough growth potential. The segment generated double-digit revenue growth in several quarters in the past, and this quarter too is no exception. The growth was mainly due to improving client base.
As per the U.S.’ Affordable Care Act, SMB owners with more than 50 employees are required to offer health insurance to their employees, failing which will attract significant penalties starting January 2015. This will raise demand for HR services, and Paychex could be a big beneficiary as it offers insurance services under this segment. Last quarter, the company’s insurance service revenue grew on account of higher number of insurance applicants and premium amount.
It’s true that improving employment can boost Paychex’s fundamentals. But growing habits of spending among the SMBs could also be a revenue driver for the company. Although stiff competition from ADP would be a concern, Paychex’s ability to offer advanced solutions could solidify further growth.