ADP Automatic Data Processing Inc

Paychex Inc. (PAYX) is scheduled to announce its first quarter fiscal 2012 results on September 27, and we notice no movement in analyst estimates at this point.

Fourth Quarter Overview

Paychex delivered mediocre fourth quarter 2011 results, with earnings of 33 cents per share just matching the Zacks Consensus Estimate. The quarter’s results indicated an improving client retention rate and higher checks per client, but lower sale of new units remained an overhang.

Paychex’ fourth quarter revenues grew 5.3% year over year backed by increases of 8.7% in Human Resources Services revenue and 4.6% in the Payroll Service revenue. But the reported revenue was below the Zacks Consensus Estimate.

Total operating costs increased 5.4% year over year, reflecting higher acquisition and training costs, partially offset by a higher utilization rate and lower headcount. Operating margin remained flat year over year at 35.0%.

Guidance

For fiscal 2012, Paychex expects a 5–7% increase in Payroll Service revenues compared to the year-ago quarter. Human Resource Services revenues are expected to increase in the range of 12.0% to 15.0%.

Total service revenue is likely to grow in the range of 7% to 9%. The company expects a 12–14% decline in interest on funds held for clients and a roughly 2% increase in net investment income.

Interest on funds held for clients and investment income for fiscal 2012 are expected to be impacted by the low interest rate environment. However, investment of cash generated from operations is expected to continue, so investment income will increase.

Net operating income is expected in the range of 35–36% of total service revenue. The effective tax rate is expected to be roughly 35% and net margin is projected at between 5% and 7%.

The guidance for fiscal 2012 includes anticipated results from Paychex’s acquisition of SurePayroll Inc. and its ePlan Services. The acquisition is expected to have approximately a 2% positive impact on revenue, nonetheless resulting in earnings dilution of around 1 cent per share on a GAAP basis due to amortization on acquired intangible assets and some one-time acquisition costs.

Agreement of Analysts

Out of the 15 analysts providing estimates for the first quarter, none made any revision in the last thirty days. However, out of the 18 analysts providing estimates for fiscal 2012, one raised the estimate in the last 7 days while another reduced the estimate in the last 30 days.

The nominal change to first quarter estimates point to the fact that there was no major catalyst during the quarter that could drive results. Consequently, the analysts are sticking to their estimates projected post fourth quarter earnings.

But some analysts prefer to remain cautious based on management’s commentary of not seeing a significant sign of improvement in new small-business formation. Moreover, a few analysts think that aggressive pricing from Automated Data Processing Inc. (ADP) is stealing away customers from Paychex.

The time difference between when the company receives payroll from its clients and pays it out to employees typically earns some interest for Paychex. Now, with the government contemplating to keep interest rates low, this quick income stream of the company will also be restricted.

Magnitude of Estimate Revisions

There was no change to the Zacks Consensus Estimate for the first quarter or fiscal 2012 over the past 30 days. However, the Zacks Consensus Estimate for fiscal 2012 went down a penny to $1.50 in the past ninety days.

Recommendation

The market is losing confidence on the growth of the small and medium business (SMB) group. The sector is being hit hard by lackluster demand that comes on the heels of high unemployment and inflation rates. Outsourcing companies like Paychex are highly dependent on the performance of the SMB sector and this is the reason that the company may be not see much revenue growth.

However, we remain positive on management’s positive commentary regarding continued investments in product development and synergies from the recent acquisition. We also believe that cost control will remain a catalyst for Paychex, going forward.

On the other hand, we are slightly concerned about the growing competition in the outsourcing space from big players such as Automated Data Processing Inc. and Administaff Inc., as well as limited margin expansion due to continuous investments in diverse fields.

Paychex has a Zacks # 3 Rank, implying a short-term Hold recommendation.

 
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