ADP (ADP, Financial) is a high-quality, defensive business which is in the early stages of a long-term transformation that should drive significant value creation as it closes the performance gap and achieves its structural potential.
2018 was a critical year for ADP. In response to our 2017 proxy contest, ADP made broad commitments to shareholders to accelerate revenue growth, bolster its competitive position (specifically in the enterprise market) and improve operational efficiencies and margins. ADP began to execute upon these commitments in 2018 and introduced new medium-term (fiscal year 2021) targets at its June 2018 Analyst Day.
At the Analyst Day, ADP provided a comprehensive update on the business trajectory and next-generation product portfolio. ADP committed to achieving accelerated revenue growth and operational efficiency improvements (targeting 23% to 25% adjusted EBIT margins) over the coming years. These projections represent substantial increases in management’s prior guidance. ADP’s new targets provide a credible plan for ADP to realize $7 of earnings per share by FY 2021 (vs. $4 at the time of our initial investment). We believe the targets still only capture a fraction of ADP’s structural potential, as we expect it will exceed its medium-term targets and make accelerated margin progress thereafter.
In support of the operating targets communicated at the Analyst Day, ADP executed numerous transformation initiatives in 2018, including accelerating the company’s Service Alignment Initiative, executing an Early Retirement Program, moving up the roll-out of its next-generation product portfolio and strengthening the talent and performance culture at the company. In support of ADP’s transformation, the company promoted a current executive to Chief Transformation Officer and has further bolstered the management team with new external hires (including a new Chief Strategy Officer and Chief Financial Officer). We view the hiring of external executives with relevant skills and fresh perspectives positively as it further assists ADP in executing on its transformation.
Recent financial results have provided some early validation of the transformation underway at ADP as evidenced by accelerated organic growth, significant margin expansion and upward revisions in current fiscal year 2019 earnings-per-share guidance which now stands at $5.30 to $5.40 per share (an increase of 17% to 19% over the previous year). We believe ADP’s ongoing transformation will be further demonstrated over the coming quarters.
We believe ADP can sustain mid-to-high-single-digit top-line growth, which when coupled with the substantial opportunity to improve ADP’s cost structure and the high operating leverage realized on incremental revenue, should allow ADP to compound earnings per share at a mid-to-high-teens growth rate for many years. At present, ADP trades at 25 times our estimate of next-twelve-months earnings which is below our estimate of the company’s intrinsic value based upon its high-quality defensive business and accelerated earnings growth profile. ADP shares appreciated 14% in 2018 including dividends and 19% 2019 year-to-date.
From Bill Ackman (Trades, Portfolio)'s Pershing Square 2018 annual shareholder letter.
