The Department of Labor came out with its weekly jobless report Thursday, among other data, that may have indicated a moderately positive outlook for the growing economy. MarketWatch somewhat refuted this idea, particularly on lower job claims, as an exaggeration brought by the holidays observed in December.
Automatic Data Processing (ADP, Financial), a 67-year-old business services company, together with Moody’s Analytics provide their own employment figures a day or two ahead of government data. These data are considered to be good predictors of the government’s nonfarm payroll report.
(Actual and forecast nonfarm employment change figures, Investing.com)
Meanwhile, browsing Automatic Data Processing’s financials would probably be time better spent than analyzing and forecasting the aforementioned figures.
Earnings performance
Automatic Data Processing reported its first quarter fiscal 2017 results on Nov. 2, 2016. The $46.5 billion business services company reported a 7.5% sales growth to $2.9 billion and 9.5% profit growth to $368.7 million compared to prior year figures. Automatic Data Processing shares traded on heavy volume and closed 3.5% higher the following day, compared to the Standard & Poor's 500 index -0.65% change.
"We are off to a solid start in fiscal 2017 and are pleased with the strategic and operational progress we achieved during the quarter. In particular, we believe efforts to align our service model to our HCM solution strategy and upgrade our clients to our strategic cloud platforms are having a positive impact on our business performance." – Carlos Rodriguez, president and CEO, Automatic Data Processing
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Fiscal 2017 outlook
Automatic Data Processing expects full-year revenue growth of 7% to 8% and a diluted earnings-per-share (EPS) growth between 15% to 17% (2). These outlook figures seem bright in comparison to its five-year historical averages;Â Automatic Data Processing had sales, profit and EPS growth averages of 3.38%, 3.54% and 5.22% (1).
Market return
Investing in Automatic Data Processing shares provided a total return of 18% for the past five years compared to the S&P 500’s 7.2% and 29.6% vs. 16.9% return in the past year (1).
Valuations
Automatic Data Processing had a trailing price-earnings (P/E) ratio of 30.9 times (industry median 20), price-book (P/B) ratio of 11 (industry median 2.2) and price-sales (P/S) ratio of 3.98 times (industry median 1.3). The company also had a trailing dividend yield 2.1% with a 63% payout ratio and 1.9% share buyback ratio.
Automatic Data Processing
Automatic Data Processing was founded in 1949 (3). Automatic Data Processing aims to help its customers by relieving them of administrative tasks such as payroll among other tasks. In its filing, Automatic Data Processing provides its services to more than 650,000 clients and had no particular client representing more than 2%, or $233.4 million, of its sales in its previous fiscal year.
Automatic Data Processing also derived 85%, or $9.87 billion, of its sales in fiscal 2016 from the U.S. followed by 9.12% from Europe, 3.86% from other countries and 2.4% from Canada. Automatic Data Processing has two reportable business segments: Employer Services and Professional Employer Organization Services.
(10-K and 10-Q filings)
Employer Services
Automatic Data Processing's employer services offer a range of human resources (HR) business process outsourcing solutions including human capital management technology solutions (4).
The segment has several operations including payroll services, benefits administration, talent management, HR management, time and attendance management, insurance services, retirement services and tax and compliance services.
In fiscal 2016, Employer Services grew 4.5% and contributed 79%, or $9.2 billion, in total Automatic Data Processing sales. The segment had 31% earnings before income taxes (EBIT) margin.
In its recent first quarter fiscal 2017, the Employer Services segment grew 6% and delivered an EBIT margin of 29%.
Professional Employer Organization Services
The segment, also called ADP Total Source(R), provides comprehensive employment administration outsourcing solutions in which worksite employees are co-employed by Automatic Data Processing and its clients.
In fiscal 2016, Professional Employer Organization Services grew 16% and contributed 26%, or $3 billion, in total Automatic Data Processing sales. The segment had 12% earnings before income taxes (EBIT) margin.
In its recent first-quarter fiscal 2017, the segment grew 13.3% and delivered an EBIT margin of 13.5%.
Cash, debt and book value
As of Sept. 30, 2016, Automatic Data Processing had $2.8 billion in cash and $2 billion in debt with a 0.47 debt-equity ratio, compared to 0.43 year on year. Automatic Data Processing also had 6.6% of its $34.3 billion assets in goodwill and intangibles while having a book value of $4.25 billion compared to $4.63 billion year on year.
(10-Q)
Marked increase cash flow intake in its account receivables helped Automatic Data Processing grew its total cash flow from operations by 202% to $330 million for its first-quarter 2017. Automatic Data Processing also had $281 million in free cash flow in the period compared to $53.5 million year on year.
In its recent quarter, Automatic Data Processing allocated 203%, or $570.4 million, of its free cash flow as dividends and share repurchases for its shareholders.
(10-K)
In its recent three years of operations, Automatic Data Processing had a three-year average growth of 5.9% in its cash flow from operations. The business services company also allocates a minor amount of its cash flow in capital expenditures. In return, Automatic Data Processing had bountiful free cash flow figures $1.66 billion, $1.75 billion and $1.69 billion in fiscal years 2014, 2015 and 2016.
(10-K, 10-Q)
Automatic Data Processing allocated an increasing amount of, even exceeding, its free cash flow in shareholder payouts with 120% of it on a three-year average.
Automatic Data Processing also places and receives in return a good amount of cash flow in marketable securities. In fiscal 2016, Automatic Data Processing allocated $5.88 billion of cash flow in marketable securities while receiving $5.2 billion in proceeds and maturities.
In addition, Automatic Data Processing carries a good amount of cash flow for its client funds. Automatic Data Processing impounds funds from its customers in preparation to make obligated payments such as payroll fees concerning federal, state and local tax authorities. These funds are managed separately from Automatic Data Processing’s cash and are to satisfy the aforementioned obligations.
In fiscal 2016, Automatic Data Processing issued $2.0 billion of senior unsecured notes with maturity dates in 2020 and 2025.
Conclusion
Automatic Data Processing would continue to grow its business as U.S. businesses keep hiring and requiring its services. Automatic Data Processing exemplifies a rather complex business where its services are critical in having its customer’s daily operations run well. This gives Automatic Data Processing a moat and at the same time susceptibility to overall labor market conditions.
Automatic Data Processing also has a healthy balance sheet and has used most of its free cash flow to provide payouts to its shareholders.
(Google Finance)
Meanwhile, Barclays sees Automatic Data Processing shares as an overweight and had a target price of $115. My earnings multiple-based calculations gave a value of $68 per share (4).
In summary, Automatic Data Processing would be a pass.
Notes
(1) Morningstar data.
(2) Press release: Growth figures are anticipated subsequent to dispositions of ADP’s CHSA and COBRA businesses.
(3) Moving forward information discussed here were gathered from company's 10-K and 10-Q filings unless specified.
(4) Me: five-year P/E ratio average of 25.2 times, profit growth of 3.54% and a 20% margin.
Disclosure: I do not have shares in Automatic Data Processing.
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