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I last reviewed Paycom Software (PAYC) in my February 8, 2024 post following the release of Q4 and FY2023 results. With the release of Q1 2024 results on May 1, 2024 I revisit this existing holding.
Business Overview
I have provided a brief business overview in prior posts. The best sources of information to learn about the company, however, are PAYC's website and the FY2023 Annual Report/Form 10-K.
Financials
Q1 2024 Results
PAYC's Q1 2024 results are reflected in its May 1 Earnings Release.
Its total revenue in FY2014 - FY2023 period (in billions of $) is $0.151, $0.225, $0.329, $0.433, $0.566, $0.738, $0.841. $1.056, $1.375, and $1.694. In Q1 2024 it was ~$0.5B and the FY2024 outlook is $1.860B - $1.885B.
PAYC is growing in the US and it now offers its native payroll solution in Canada, Mexico, United Kingdom, and just recently Ireland. In less than a year since PAYC announced its international expansion, its is already seeing US-based companies with an international presence look to PAYC as a global provider.
Historically, PAYC focused on the small to medium-size companies. Now, however, it is gradually moving upmarket where closing a transaction is more complex and time consuming. Nevertheless, it is achieving success. Recently, PAYC won business from the New England Patriots.
The Q1 average daily balance of funds held on behalf of clients was ~$2.6B representing a ~8% YoY increase.
The Q1 tax rate was 15% on a GAAP basis, reflecting the benefit of the forfeiture of the 2020 CEO performance award during the quarter.
Q2 and FY2024 Outlook
PAYC's Q2 outlook is:
- Total Revenues of $0.434B - $0.438B or ~9% growth at the midpoint which is comparable to Q2 2023.
- Adjusted EBITDA of $0.151B - $0.155B or a ~35% margin at the midpoint of the range.
Its FY2024 outlook is unchanged from the previously provided outlook:
- Total Revenues of $1.860B - $1.885B or ~11% YoY growth at the midpoint.
- Adjusted EBITDA of $0.720B - $0.730B or a ~39% margin at the midpoint of the range.
For Q2 and FY2024, management anticipates effective income tax rates of ~33% and ~22%, respectively, on a GAAP basis. The non-GAAP effective tax rate estimates for Q2 and FY2024 are ~25%. Quarterly fluctuations in the effective tax rates are generally due to the timing of stock compensation vesting and related tax effects.
For the remainder of 2024, PAYC expects its quarterly stock-based compensation expense to be ~$33 million.
Operating Cash Flow (OCF) and Free Cash Flow (FCF)
Depreciation often serves as an indicator of how much needs to be invested to maintain assets in good operating condition.
In FY2014 - FY2023, PAYC generated OCF of approximately (in millions of $) 22, 43, 99, 130, 185, 224, 227, 319, 365, 485 and ~148.6 in Q1 2024.
In FY2014 - FY2023, PAYC generated FCF of approximately (in millions of $) 8.07, 26.42, 55.01, 70.76, 124.91, 131.33, 133.11, 193.17, 228.31, 292 and ~101 in Q1 2024.
The annual depreciation and amortization in FY2021 - FY2023 was ~$67.2, ~$92.7, and ~$114 million. In Q1 2024 it was ~$32.5 million.
Annual CAPEX was ~$126, ~$137, and ~$197 during the same period. In Q1 2024 it was ~$47.7 million as PAYC continues to invest in its long-term future growth in areas of automation, AI and international expansion.
PAYC's 5th building in Oklahoma City is substantially complete and will be placed into service in Q2.
Management continues to estimated total FY2024 CAPEX as a percent of revenues to be ~12% versus 11.3% in FY2023. This percentage, however, is expect to decline beginning in FY2025.
It is encouraging that PAYC has not had to rely on debt to fund its CAPEX requirements.
Return On Invested Capital (ROIC)
In FY2014 - FY2023, PAYC's ROIC (%) was 8.53, 19.14, 32.75, 42.53, 50.94, 39.04, 23.03, 24.35, 26.56, and 27.53.
High quality companies often generate a high ROIC. If a company generates a high ROIC, it needs to invest less to achieve a certain growth rate thus reducing the need for external capital.
A company that generates $0.15/profit for every $1 invested, for example, achieves a ROIC of 15%. I consider a ~15%+ ROIC to be a reasonable minimum threshold because most of the time, a company's cost of capital will be lower than this level. In the past 7 fiscal years, PAYC's ROIC has exceeded 20%!
When a company consistently generates a high ROIC over the long term and it is growing its revenue, it can reinvest a portion of its profits under favorable conditions thereby leading to a compounding effect. I would much rather invest in a growing company that can reinvest to create greater shareholder value than to invest in a company that has limited growth opportunities and thus chooses to distribute a growing dividend.
Risk Assessment
PAYC has no debt to be rated.
At the end of Q1, PAYC had ~$0.371B in cash and cash equivalents. Current liabilities before client funds obligation (excluding deferred revenue of $27.6 million) was $0.186B.
At FYE2023, it had ~$0.294B of cash and cash equivalents. Current liabilities before client funds obligation (excluding deferred revenue of $22.8 million) was ~$0.184B.
The short-term and long-term deferred revenue represents funds received from clients in advance of providing services.
Dividend and Dividend Yield
PAYC has a brief dividend history having distributed its first quarterly dividend on June 12, 2023.
When I wrote my February 8 post, I had anticipated that PAYC would declare a dividend increase. On April 29, however, PAYC's Board declared a 5th consecutive $0.375/share quarterly dividend. This is to be paid on June 10, 2024, to all stockholders of record as of the close of business on May 28, 2024.
Dividend metrics are of little relevance in my investment decision making process. I would much rather a company retain funds to grow the business if this is the most beneficial form of capital allocation.
The weighted average diluted shares outstanding in FY2021 - FY2023 is 57.974, 58.175, and 58.191 million and 56.552 million in Q1 2024.
In May 2016, PAYC's Board authorized a stock repurchase plan allowing for the repurchase of shares of common stock in open market transactions at prevailing market prices, in privately negotiated transactions or by other means in accordance with federal securities laws.
- During FY2023, PAYC repurchased an aggregate of 1,495,752 shares at an average cost of $200.93/share, including 51,119 shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of equity incentive awards.
- During FY2022, PAYC repurchased an aggregate of 364,667 shares at an average cost of $273.74/share, including 17,355 shares withheld to satisfy tax withholding obligations for certain
employees upon the vesting of the restricted stock.
Since the initial authorization of the stock repurchase plan, PAYC's Board has amended, extended and authorized new stock repurchase plans from time to time. Most recently, in August 2022, the Board authorized the repurchase of up to $1.1B of common stock. At the end of Q1, PAYC has ~$0.796B under its buyback authorization.
The current stock repurchase plan expires on August 15, 2024; I expect a newly authorized stock repurchase plan will be approved shortly.
Valuation
PAYC's FY2014 - FY2023 diluted PE levels are 117.59, 66.90, 75.78, 73.32, 92.90, 160.37, 140.74, 72.17, and 35.4.
In my February 8, 2024 post I noted that PAYC generated $5.88 of GAAP EPS and $7.75 of adjusted diluted EPS in FY2023. Using my ~$192 purchase price, the current diluted PE was ~32.7 and the current adjusted diluted PE was ~24.8.
PAYC generated ~$292.450 million of FCF in FY2023. Using the weighted average diluted shares outstanding in FY2023 of 57.974 million, the FCF/share was ~$5.04. Using my recent ~$192 purchase price, the current P/FCF was ~38. Were we to use the 57.229 weighted average diluted shares outstanding in Q4 2023, the FCF/share was ~$5.11 and a current P/FCF was ~37.6.
PAYC's current forward-adjusted diluted PE levels using current broker estimates and my ~$192 purchase price were:
- FY2024 - 21 brokers - ~24.5 using the mean of $7.83 and low/high of $6.82 - $8.48.
- FY2025 - 19 brokers - ~21.6 using the mean of $8.82 and low/high of $7.94 - $9.6.
- FY2026 - 5 brokers - ~18.3 using the mean of $10.49 and low/high of $10.03 - $10.87.
On May 2, I acquired an additional 100 shares @ ~$163. Using this purchase price and PAYC's current forward-adjusted diluted EPS broker estimates, PAYC's forward adjusted diluted PE levels are:
- FY2024 - 20 brokers - ~21 using the mean of $7.72 and low/high of $6.82 - $8.02.
- FY2025 - 20 brokers - ~18.6 using the mean of $8.78 and low/high of $7.81 - $9.53.
- FY2026 - 6 brokers - ~15.6 using the mean of $10.48 and low/high of $9.79 - $10.87.
In Q1 alone, PAYC generated ~$101 million of FCF. If PAYC can generate ~$75 million of FCF in each of the next 3 quarters, FY2024 FCF should be ~$326 million.
The weighted average diluted shares outstanding in Q1 is 56.552 million. PAYC expects its quarterly stock-based compensation expense to be ~$33 million for the remainder of FY2024. If it repurchases shares at an average price of $185, this amount to ~178 thousand shares quarterly or ~534 thousand for the remainder of FY2024. If we conservatively estimate the weighted average diluted shares outstanding in FY2024 drops to 56.3 million and use ~$326 million of FY2024 FCF, we arrive at a FCF/share of ~$5.80. Divide the ~$163 share price by ~$5.80 and we get a forward P/FCF of ~28. This is certainly an improvement from prior levels.
Final Thoughts
When I wrote my February 8 post, I disclosed the recent purchase of an additional 100 shares @ ~$192 in the 'Core' account within the FFJ Portfolio thus bringing my exposure to 450 shares.
Having fallen out of favor with investors, PAYC's share price performance has been abysmal of late. I view this as an opportunity to increase my exposure and acquired 50 shares @ $188.60 on February 9, 100 shares @ $178.19 on March 4, and 100 shares on May 2 @ ~$163. My total PAYC exposure is now 700 shares.
Some investors may question whether I am 'catching a falling knife' by continuing to add to my PAYC exposure as its share price plummets. I, however, continue to like the company's long-term prospects because:
- PAYC is growing in the US where it estimates it only has ~5% of the total addressable market.
- In less than a year since PAYC announced its international expansion, it is already seeing US-based companies with an international presence look to PAYC as a global provider; it now offers its native payroll solution in Canada, Mexico, United Kingdom, and recently expanded into Ireland.
- Its total revenue in FY2014 - FY2023 period (in billions of $) is $0.151, $0.225, $0.329, $0.433, $0.566, $0.738, $0.841. $1.056, $1.375, and $1.694. In Q1 2024 it was ~$0.5B and the FY2024 outlook is $1.860B - $1.885B.
- It has no debt!
- It generates a very attractive ROIC.
- Annual CAPEX is expected to start declining in FY2025 which should contribute to an increasing in FCF.
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 PAYC.
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 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.
