Additional ADP Shares Acquired In A Retirement Account

 

I last reviewed Automatic Data Processing (ADP) in my January 26 post. Based on my analysis, I added a few additional shares at ~$225 in a retirement account where most of my ADP exposure is held; I do not disclose retirement account details. This explains why ADP was my 15th largest holding when I completed my Mid 2022 Investment Holdings Review yet I only reflect 100 shares in the FFJ Portfolio.

In this brief post, I:

• touch upon ADP's valuation; and
• disclose the purchase of additional shares @ ~$207/share on May 30 in the same retirement account through which I made my January purchase.

Financial Review

Q3 and YTD2023 Results

ADP's Q3 2023 results (as of March 31, 2023) are reflected in this Earnings Release, Earnings Presentation, and Form 10-Q.

ADP's CAPEX requirements are well below those of capital-intensive industries. This is a strong advantage when it comes to generating Free Cash Flow (FCF).

ADP's FY2012 - FY2022 FCF (in Billions of $) is $1.661, $1.342, $1.518, $1.639, $1.511, $1.655, $2.044, $2.122, $2.410, $2.587, and $2.925. YTD2023 FCF is ~$2.59B.

• Net cash flows provided by operating activities: $3.0219B
• Less CAPEX: ~$0.1454B
• Less Additions to intangibles: ~$0.2853B
• YTD FCF: ~$2.5912B

FY2023 Outlook

The following reflects ADP's FY2023 outlook at the end of FY2022 and in each quarter of FY2023.

We see that the Revenue, Adjusted EBIT Margin, and Adjusted Diluted EPS outlook for 'Total ADP' has been revised higher from the original outlook communicated to the investment community at FYE2022.

Clients Funds Investment Strategy

A comprehensive overview of ADP's Clients Funds Investment Strategy is found in Note 4 in ADP's FY2022 Form 10-K starting on page 62 of 95.

The purpose of ADP’s Client Funds Extended Investment Strategy is to generate income from significant client fund balances. When deemed prudent, ADP will further enhance its investment returns by investing long and borrowing short to take advantage of the yield spread.

This strategy is structured to allow ADP to average its way through an interest rate cycle by laddering the maturities of investments out to 5 years (in the case of the extended portfolio) and out to 10 years (in the case of the long portfolio). This investment strategy is supported by ADP's short-term financing arrangements necessary to satisfy short-term funding requirements relating to client funds obligations.

While client funds interest revenue was up in Q2, the increase was a bit lighter than expected. Management attributes this to a slight pullback in yields from where they were 3 months ago when the prior outlook was provided.

The mid and the long rates have come down following the release of previous guidance. Even though short-term rates have increased, some of ADP's short-term borrowing costs have increased in its commercial paper program. The reason the client fund interest forecast is revised slightly lower is to reflect these increased borrowing rates and the softening of deposit interest rates in the mid and the longer term.

When ADP released its FY2023 outlook at the end of Q2 2023, it lowered its client funds interest growth from 4% - 6% to 4% - 5%. This was primarily because of changes to assumptions around average wage related to worker mix, tax rates, and the impact of the lapping of the payroll tax deferral.

The following table reflects ADP's current FY2023 outlook regarding its Client Funds Investment Strategy.

This is what ADP provided when it released Q2 2023 results.

This is what ADP provided when it released Q1 2023 results.

Risk Assessment

The following is a schedule of ADP's long-term debt as of FYE2022. The amount outstanding at the end of Q3 2023 is $2,988.6B.

We see from this schedule that the maturity dates of these Notes is well distributed. I envision no issue in ADP being able to repay/renegotiate these Notes come maturity.

There is no change to ADP's senior unsecured domestic long-term debt credit ratings from the time of my last review.

• Moody's: Aa3
• S&P Global: AA-
• Fitch: AA-

The outlook assigned by all 3 rating agencies is 'stable'.

All ratings are in the bottom tier of the upper medium-grade investment-grade category. They define ADP as having a very strong capacity to meet its financial commitments and differ from the highest-rated companies only to a small degree. 

These ratings satisfy my conservative investment preferences.

Dividends and Share Repurchases

Dividends and Dividend Yield

ADP's dividend history on its website is not current as I compose this post; the dividend history reflects the most recent quarterly dividend as being $1.25 payable on January 1, 2023.

On April 12, however, ADP declared its 3rd quarterly $1.25/share dividend that is payable on July 1 to shareholders of record on June 9.

Using my recent ~$207 purchase price, the dividend yield is ~2.4% versus ~2.22% when I purchased shares in January.

Share Repurchases

The FY2012 - FY2022 weighted average share outstanding (in millions rounded) is 492, 487, 483, 476, 459, 450, 443, 438, 433, 428 and 421.

• FY2019 - ADP purchased ~6.5 million shares at an average price per share of $143.02.
• FY2020 - ADP purchased ~6.2 million shares at an average price per share of $160.61.
• FY2021 - ADP purchased ~8.2 million shares at an average price per share of $170.04.
  
• FY2022 - ADP purchased ~9.2 million shares at an average price per share of $214.40.

In the first 3 quarters of FY2023, ADP purchased ~3.5 million shares at an average price per share of $231.45 versus 7.0 million shares at an average price per share of $213.17 during
the nine months ended March 31, 2022.

Valuation

ADP's diluted PE ratio in the FY2012 - FY2022 is 20.41, 28.25, 26.22, 28.33, 30.77, 29.74, 33.79, 31.40, 30.59, 39.02, and 33.08.

When I wrote my October 31, 2022 post, ADP forecasted diluted EPS AND adjusted diluted EPS growth of 15% - 17% growth. Using FY2022's $7.00 diluted EPS and $7.01 adjusted diluted EPS and this growth range, I expected FY2023 diluted and adjusted diluted EPS of ~$8.06 - ~$8.20. With shares trading at $242.65, the forward diluted and forward adjusted diluted PE ratios were ~29.6 - ~30.1.

In addition, the forward-adjusted diluted PE levels based on broker estimates were:

• FY2023 - 19 brokers - mean of $8.11 and low/high of $7.92 - $8.23. Using the mean estimate, the forward adjusted diluted PE is ~30 and ~29.5 if I use $8.23.
• FY2024 - 18 brokers - mean of $9.00 and low/high of $8.25 - $9.25. Using the mean estimate, the forward adjusted diluted PE is ~27 and ~26.2 if I use $9.25.
• FY2025 - 8 brokers - mean of $10.12 and low/high of $9.65 - $10.36. Using the mean estimate, the forward adjusted diluted PE is ~24 and ~23.4 if I use $10.36.

At the time, I concluded that ADP was overvalued.

The outlook for the remainder of FY2023, when I wrote my January post, reflected no change to management's FY2023 diluted EPS AND adjusted diluted EPS growth outlook. ADP's share price, however, dropped to my ~$225 purchase price thus leading to a forward adjusted diluted PE range of ~27.4 - ~28.

I anticipated minor revisions to current broker estimates shortly after writing my January post. However, using the estimates that were currently available, I arrived at the following forward-adjusted diluted PE levels:

• FY2023 - 18 brokers - mean of $8.11 and low/high of $7.96 - $8.23. Using the mean estimate, the forward adjusted diluted PE was ~27.7 and ~27.3 if I use $8.23.
• FY2024 - 18 brokers - mean of $8.97 and low/high of $8.25 - $9.32. Using the mean estimate, the forward adjusted diluted PE was ~25.1 and ~24.1 if I use $9.32.
• FY2025 - 9 brokers - mean of $10.02 and low/high of $9.67 - $10.50. Using the mean estimate, the forward adjusted diluted PE was ~22.5 and ~21.4 if I use $10.50.

As I compose this post, management's current FY2023 outlook calls for adjusted diluted EPS growth of 16% - 17% from FY2022 results. Since ADP generated $7.00 diluted EPS and $7.01 adjusted diluted EPS in FY2022, I expect FY2023 diluted and adjusted diluted EPS of ~$8.12 - ~$8.20. Using my recent ~$207 purchase price, the forward adjusted diluted PE is ~25.4 (~$207/ ~$8.16).

Using the current broker estimates, I arrive at the following forward-adjusted diluted PE levels:

• FY2023 - 18 brokers - mean of $8.17 and low/high of $8.12 - $8.21. Using the mean estimate, the forward adjusted diluted PE is ~25.3 and ~25.2 if I use $8.21.
• FY2024 - 18 brokers - mean of $8.94 and low/high of $8.50 - $9.26. Using the mean estimate, the forward adjusted diluted PE is ~23.2 and ~22.4 if I use $9.26.
• FY2025 - 11 brokers - mean of $9.90 and low/high of $9.59 - $10.17. Using the mean estimate, the forward adjusted diluted PE is ~21 and ~20.4 if I use $10.17.

Final Thoughts

I consider ADP to be currently attractively valued. ADP, however, could become even more attractively valued if there is no imminent resolution to the US debt ceiling. Since I have no idea of what will be the outcome of the debt ceiling negotiations, the best I can do is to invest in great companies I think are likely to be more valuable in the future.

I could have made this recent share purchase through a taxable account. However, I hold a considerable number of ADP shares in a retirement account. I have, therefore, elected to just add to my existing position rather than start a new ADP position in a taxable account.

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long ADP.

Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.