Automatic Data Processing Inc. (ADP, Financial), one of the largest business outsourcing companies found anywhere in the world, recently reported earnings results. The company managed to top estimates for both revenue and earnings per share.
While this is good news, what I really took away from the quarter was that Automatic Data Processing believes its fiscal year will be better than expected as the company revised its guidance higher for the top and bottom lines. This is despite the impact that the coronavirus is having on normal business operations for its customers.
Recent performance plus the revised guidance led us to increase our position in the company.
Let's examine the quarter in more detail to see why we added to Automatic Data Processing.
Quarterly highlights
Automatic Data Processing reported earnings results for the first quarter of fiscal 2021 on Oct. 28. The company's earnings of $1.41 per share were 5.2% better than the prior year and 43 cents above what Wall Street analysts had expected. Revenue was down 0.7% to $3.47 billion, but topped estimates by almost $200 million.
The Employer Services segment, which contributed approximately 70% of total revenue, was down 3% to $2.44 billion. Pays per control were down 9%, though this was a deceleration from an 11% decrease in the fourth quarter of fiscal 2020. Margins expanded 120 basis points to 29%.
Also, on the positive side, this segment saw new business bookings increase 2%. Another good sign was the segment's bookings and retention were a first-quarter record. Automatic Data Processing surpassed the 700,000 mark for customers, something it hasn't done since before the Covid-19 pandemic.
Average interest yield on client funds decreased 30 basis points to 1.9% as low rates remain a headwind for the company. Average client funds decreased 7% to $22 billion, but this was better than the earlier projections of double-digit declines.
Professional Employer Organization Services had revenue growth of 4% to $1.1 billion. Revenues excluding zero-margin benefits pass-throughs were lower by 1% and average work-site employees dropped just 3% to 547,000. However, results were better than expected in both areas. Same-store pays were down, in line with leaderships' expectations of a mid-single-digit decline.
Automatic Data Processing also controlled costs well, which, when combined with better bookings and retention rates, led to a 120-basis point improvement in the Ebit margin to 29%. The company had expected the first quarter to see margins compress due to high margin revenue loss, but that didn't occur to the extent that management had forecasted.
The better-than-expected performance led the company to revise its guidance for fiscal year 2021.
Source: Automatic Data Processing's First-Quarter Earnings Presentation.
Automatic Data Processing expects revenue in a range of down 1% to up 1% compared to prior guidance of a range of down 4% to down 1%. Adjusted earnings per share is now expected to decline 3% to 7%, an improvement from its previous forecast of a decrease of 13% to 18%. The company also sees an improvement on nearly every other important metric as well.
The company's performance in the face of Covid-19-related headwinds was solid. Even better, Automatic Data Processing believes that results for the year aren't as dire as first believed.
For these reasons, we added to our position in Automatic Data Processing at a price of $155 on Oct. 28. The market seemed to share our sentiment on the company as the stock was up more than 6% to end the day following the earnings release, while the market itself was down pretty substantially.
But did we pay a fair price for our new shares of the company?
Valuation
Using our purchase price and the expected midpoint for adjusted earnings per share of $5.62, shares of Automatic Data Processing trade with a forward price-earnings ratio of 27.6. This is less than the five-year average price-earnings ratio of 28.3.
According to the GuruFocus Value chart, shares of the company are fairly valued today.
Automatic Data Processing has a current GF Value of $154.85. Our purchase price was just above this level, meaning we paid close to the stock's intrinsic value. The price-to-GF Value ratio is barely above 1.
We were willing to buy the stock at a fairly valued level because of recent results and an improvement in guidance. The company's 44 consecutive years of dividend increases is also attractive to us as divdiend growth investors.
Final thoughts
With Covid-19 continuing to impact businesses and worksites, investors can be forgiven if they thought that a payroll processing and human resource company might face significant headwinds.
Instead, Automatic Data Processing performed better than expected in the most recent quarter and has now guided toward a fiscal year that likely isn't as bad as thought just a few months ago.
This strength in business results and lifting of the gudiance made for a compelling argument for us to add to our position in the company, even though it trades near its intrinsic value.
Disclosure: The author maintains a long position in Automatic Data Processing.
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