In times of uncertainty, I prefer to circle back to names that have long histories of dividend growth as these are the companies to own during weaker periods. These companies have proven to be successful at navigating difficult periods and still raise their dividend.
These companies have to have proven business models in order to do so. This is one reason why I think dividend growth investors should be considering Automatic Data Processing Inc. (ADP, Financial) at the current price.
Let’s look at the company and its dividend more in detail to see why I believe it could be a good option.
Company background and results history
Automatic Data Processing is a leading provider of business services, with the company offering payroll, human resources and other business-related services to clients. The company counts more than 700,000 corporations among its customer base. The $85 billion company generates nearly $16 billion in annual revenue.
The company announced fiscal second-quarter 2022 results on Jan. 26. Revenue grew 9% to $4 billion, which was $20 million above what Wall Street analysts had anticipated. Adjusted earnings per share of $1.65 compared favorably to $1.52 in the prior year and was 2 cents better than expected.
Automatic Data Processing also raised its guidance for the fiscal year, with leadership now expecting revenue growth of 8% to 9% versus prior guidance of 7% to 8%. Adjusted earnings per share are now forecasted to grow 12% to 14% compared to prior guidance of 11% to 13%. At the midpoint, this would imply adjusted earnings per share of $6.80 for fiscal year 2022.
The company is accustomed to producing at least solid growth. Revenue has a compound annual growth rate of 4.9% and 3.9% over the last five- and 10-year periods.
Revenue growth has been modest, but the bottom-line performance has been very impressive. Earnings per share grew by 14.1% since 2017 and 8.9% since 2012.
A reduction of some 60 million shares enabled some of this growth, but net profit has more than doubled over the last decade. This is due to Automatic Data Processing’s ability to improve its net profit margin, which went from 13% in 2012 to 17.3% last fiscal year.
Producing more profit from its business has allowed the company to continue to add to its very impressive dividend growth streak.
Dividend history and recession performance
Automatic Data Processing has raised its dividend for 47 consecutive years, which places it among the Dividend Aristocrats. There are less 70 names within this group that have the necessary requirements of 25 years of growth and membership in the S&P 500 Index. Automatic Data Processing is also just three years away from joining the Dividend Kings, which are those companies with at least five decades of dividend growth.
The company has managed to reach these heights of dividend growth because its business model works in all manner of economic environments.
Below are the company’s adjusted earnings per share results before, during and after the Great Recession:
- 2006 adjusted earnings per share: $1.85
- 2007 adjusted earnings per share: $1.83 (1.1% decrease)
- 2008 adjusted earnings per share: $2.20 (20.2% increase)
- 2009 adjusted earnings per share: $2.39 (8.6% increase)
- 2010 adjusted earnings per share: $2.39 (no change)
- 2011 adjusted earnings per share: $2.52 (5.4% increase)
- 2012 adjusted earnings per share: $2.82 (11.9% increase)
Without any further knowledge, you might have thought the results for the 2007 to 2009 period would have been one of expansion. A reduced share count does impact the growth rates slightly, but Automatic Data Processing grew net profit in both 2008 and 2009.
Importantly for dividend growth investors, the company’s dividend grew by a total of 49% from 2007 to 2009.
Earnings and dividend growth were impressive during what was one of the most challenging operating environments in some time.
For a more recent example, Automatic Data Processing also withstood the worst of the Covid-19 pandemic. Earnings grew 9% for 2020 while the dividend inched higher by 2.2%. The company followed up that raise with a nearly 12% increase the following year.
Shares of Automatic Data Processing yield 2.1% as of the most recent trading close. This is below the 10-year average yield of 2.4%, but very much in line with the average yield of the past half-decade.
Dividend growth and payout ratios
Automatic Data Processing’s dividend has a CAGR of 13.4% and 10.2% over the last five and 10 years, respectively. This shows remarkable consistency over both time frames.
The company’s dividend continues to rise, even in difficult circumstances, because its payout ratios are very reasonable.
Let’s start with the company’s earnings payout ratio. Shareholders received $3.70 of dividends per share in the most recent fiscal year. The company’s earnings per share totaled $6.07 for the period, giving Automatic Data Processing an earnings payout ratio of 61%. The last 10 years has seen the company’s earnings payout ratio average 60%, so last year’s result was very much in the normal range.
For fiscal year 2022, dividends per share should be $4.16. Using the midpoint of company's guidance, the payout ratio is projected to be 61%, also right near the long-term average.
Free cash flow also paints a picture of remarkable consistency.
Over the last year, the company distributed $1.58 billion in dividends, generating free cash flow of $2.59 billion. This resulted in a free cash flow payout ratio of 61%, right in the area of the average free cash flow payout ratio of 58% for the previous three years.
Using either earnings per share or free cash flow, Automatic Data Processing's dividend looks to be safe.
The impact of debt of dividend security
Lastly, lets consider the company’s debt obligations in relation to dividend safety.
Automatic Data Processing’s interest expense over the last 12 months was $67.6 million. With long-term debt standing at $3.35 billion, the company has a weighted average interest rate of just 2.0%.
The chart below shows how high the company’s weighted average interest rate would need to increase before free cash flow did not fully cover dividend payments.
Source: Author’s calculations.
The image above shows that Automatic Data Processing’s weighted average interest rate would need to surpass 32% before free cash flow wasn’t sufficient to make dividend payments. With the current weighted average interest rate in the very low single-digits, it looks like debt obligations will not inhibit future dividend raises.
Valuation
Using leadership’s guidance for adjusted earnings per share for fiscal year 2022, Automatic Data Processing trades with a forward price-earnings ratio of 29.4. This is a premium valuation, but not too far off its 10-year average multiple of 26.2 times earnings and its five-year average multiple of 28.5 times earnings.
The GF Value Line says shares are fairly valued currently.
With a share price of $200.22 and a GF Value of $198.90, Automatic Data Processing has a price-to-GF Value ratio of 1.01.
Final thoughts
Automatic Data Processing’s dividend growth streak is nearly five decades in length, due to the success of its business model over long periods of time. Even in recessions, the company’s business has improved and the dividend has been raised at high levels.
The company's payout ratios are incredibly consistent with their averages. Shares also provide a higher level of income than the S&P 500 Index, which has an average yield of just 1.4%.
For investors looking for a well-run company with a strong business model, a long track record of dividend growth and trading near its intrinsic value, Automatic Data Processing could be an excellent investment option.
