Invest In Paychex For Peace of Mind

I invest in Paychex (PAYX) for peace of mind and have been a shareholder in one investment account or another since July 8, 2009.

This post reviews PAYX's results for the first half of FY2022 and guidance for FY2022.

Business Overview

PAYX, founded in 1979, is a human resource (HR) software and services company. It offers integrated human capital management (HCM) solutions for HR, payroll, benefits, and
insurance solutions for small- to medium-sized businesses.

As of May 31, 2021, PAYX served more than 710,000 payroll clients across more than 100 locations in the U.S. and Europe. It pays 1 out of every 12 American private-sector employees.

The company's portfolio of HCM and employee benefit-related services is disaggregated into two categories:

  • Management Solutions
  • Professional Employer Organization (PEO) and Insurance Solutions.

The market for HCM solutions is rapidly evolving, highly competitive and subject to changing technology, shifting client needs and frequent introduction of new products and services. PAYX's competitors range from small, regional firms to large, well-established international firms with multiple product offerings.

Many of PAYX's competitors provide HCM solutions by various means. Some continue to deliver legacy enterprise software. As demand for greater flexibility and access to information grows, however, there will likely be increased competition in the delivery of HCM cloud-based solutions by other SaaS (software as a service) providers.

Competition is primarily based on service responsiveness, product quality and reputation, breadth of service, application offering and price. The importance of these factors depends on the size of the business. Price tends to be the most important factor for smaller businesses with fewer employees, while the scope of features and customization is more important to larger businesses. The implementation experience, regardless of company size, is an important factor as all organizations are seeking a streamlined and simplified process.

I encourage investors unfamiliar with PAYX to read Part 1 of the FY2021 10-K to get a good overview of the company.

Acquisitions

To retain its competitive advantage, PAYX periodically completes acquisitions to bolster its product offering. The purchase price of most acquisitions is immaterial.

The following is a list of a few of PAYX's larger acquisitions.

Advance Partners

On December 22, 2015, PAYX completed the acquisition of Advance Partners. Advance Partners offers customizable solutions to the temporary staffing industry, including payroll funding and outsourcing services, which include payroll, invoicing, and tax preparation.

PAYX paid, net of cash acquired, $296.1 million for the acquisition. The acquisition consideration was comprised of a base purchase price of $190.5 million plus immediate settlement of debt totalling $118.4 million, net of $12.8 million in cash acquired. Accounts receivable balances acquired, net of allowance for doubtful accounts, and less amounts due to clients related to funding arrangements totalled $164.8 million. Goodwill of $95.6 million was tax-deductible and was recorded as a result of the acquisition.

HR Outsourcing Holding

Effective August 18, 2017, PAYX acquired HR Outsourcing Holdings, Inc. (HROI) and all of its operating subsidiaries. HROI is a national PEO that provides HR solutions to small- and medium-sized businesses in more than 35 states. The acquisition expanded PAYX's presence in the PEO industry.

The purchase price was $75.4 million and was comprised of $42.2 million of cash plus $33.2 million issued in the form of PAYX common stock. Goodwill of $51.1 million was not tax-deductible.

Lessor Group

On February 28, 2018, PAYX completed the acquisition of Lessor Group, a market-leading provider of payroll and HCM software solutions. Lessor is headquartered in Denmark and serves clients in Northern Europe.

The purchase price was $160.6 million, net of cash acquired. Goodwill of $119.2 million was not tax-deductible.

Oasis

Oasis is PAYX's most notable recent acquisition.

On November 26, 2018, PAYX announced its intent to acquire Oasis Outsourcing, an industry leader in providing HR outsourcing services; the acquisition closed on December 20, 2018.

The $992.2 million purchase price was net of $262.3 million in cash acquired, including $132.1 million of restricted cash.

Funding for this acquisition was from cash on hand and $0.8B in short-term financing. Further details regarding financing arrangements are provided in the Risk Assessment section of this post.

Flock

This acquisition is much smaller than those reflected above. I included it here because it is the most recent acquisition.

In October 2021, PAYX acquired Flock, a benefits enrollment and administration, onboarding, and human resources information system (HRIS) provider. Although the terms of the acquisition were not disclosed, we see from the Consolidated Statement of Cash Flows in the Q2 Form 10-Q that PAYX reported $24.9 million under 'Acquisition of businesses, net of cash acquired'; there was no such line item in the Q1 Form 10-Q.

Financial Review

Q2 and YTD2022 Results

On December 22, 2021, PAYX issued its Q2 and YTD results and revised FY2022 guidance (Form 8-K and Form 10-Q).

 

PAYX - Q2 2022 Service Revenue

Source: PAYX Q2 2022 Earnings Presentation - December 22, 2021

PAYX's financial position remains strong. At the end of Q2, cash, restricted cash, and total corporate investments exceeded $1.1B. Total borrowings amounted to ~$0.8B

The Cash Flows from Operations were $0.555B during the first six months. This represents a~29% increase from the prior-year period.

The Free Cash Flow generated was $0.459B million, a 21% year-over-year increase.

PAYX - Q2 2022 Balance Sheet and Cash Flows

Source: PAYX Q2 2022 Earnings Presentation - December 22, 2021

FY2022 Guidance

PAYX has improved its FY2022 outlook a couple of times following the release of FY2022 guidance provided when it released FY2021 results on June 25, 2021.

PAYX - FY2022 Outlook

Source: PAYX Q2 2022 Earnings Presentation - December 22, 2021

Risk Assessment

For the longest time, PAYX had no long-term debt. On March 13, 2019, however,  it completed the private placement of Senior Notes, Series A in an aggregate principal amount of $0.4B due on March 13, 2026, and Senior Notes, Series B in an aggregate principal amount of $0.4B due on March 13, 2029. Proceeds from the Notes were used to pay off $0.8B in short-term borrowings under its JP Morgan credit facilities used to temporarily finance the acquisition of Oasis; Oasis was the US's largest privately-owned professional employer organization (PEO) and an industry leader in providing human resources outsourcing services.

Details of PAYX's credit arrangements are in Notes M and N in the FY2021 Form 10-K (pages 70 and 71 of 103).

No credit rating agency rates PAYX's debt. The risk of default, however, is satisfactory for my relatively conservative risk profile.

Dividends and Share Repurchases

Dividends and Dividend Yield

PAYX's 4th quarterly $0.66 dividend is to be distributed on February 24, 2022. Based on the current $118.67 share price, the dividend yield is ~2.2%.

I envision a $0.04 - $0.06 quarterly dividend increase announcement in late April/early May. The cash flow and earnings should be ample to service such an increase.

Share Repurchases

The weighted average number of shares outstanding is 363, 365, 366, 365, 363, 363, 362, 362, 361, and 362 (in millions) in FY2012 - FY2021.

PAYX maintains a program to repurchase up to $0.4B of its common stock, with authorization expiring on May 31, 2022. The purpose of this program is to manage common stock dilution.

During FY2020 and FY2021, PAYX 2 million shares ($171.9 million at an average price of $84.68) and 1.7 million shares ($155.7 million at an average price of $90.83), respectively. As of May 31, 2021, $72.4 million remained available under the common stock repurchase program.

In July 2021, PAYX's Board authorized an additional program allowing the repurchase of up to $0.4B of common stock. This authorization expires on January 31, 2024.

Valuation

PAYX's FY2012 - FY2020 diluted PE levels are 20.19, 28.28, 26.08, 26.31, 28.32, 29.34, 23.44, 28.54, 31.80, and 38.78.

PAYX has generated $1.83 in diluted EPS and $1.80 in adjusted diluted EPS in the first half of FY2022. When PAYX released Q2 earnings on December 22, 2021, PAYX forecast an 18 - 20% increase from $3.04 in FY2021 adjusted diluted EPS.

On this basis, FY2022 adjusted diluted EPS is forecast to be ~$3.59 - ~$3.65. Using a $3.62 mid-point and the current $118.67 share price, the forward adjusted diluted PE is ~32.5 - ~33.

If we apply a similar growth rate to $3.03 of FY2021 diluted EPS, we arrive at an FY2022 forecast of ~$3.58 - ~$3.64. Using a $3.61 mid-point and the current $118.67 share price, the forward diluted PE is roughly the same as the forward adjusted diluted PE.

Using the current guidance from the two online trading platforms I use, leads to the following forward adjusted diluted PE levels.

  • FY2022 - 16 brokers - mean of $3.63 and low/high of $3.59 - $3.68. Using the mean estimate, the forward adjusted diluted PE is ~33 and ~32 if I use $3.68.
  • FY2023 - 18 brokers - mean of $3.89 and low/high of $3.70 - $4.08. Using the mean estimate, the forward adjusted diluted PE is ~30.5 and ~29 if I use $4.08.
  • FY2024 - 10 brokers - mean of $4.20 and low/high of $4.05 - $4.42. Using the mean estimate, the forward adjusted diluted PE is ~28.3 and ~26.8 if I use $4.42.

PAYX's current valuation is slightly high. A forward-adjusted diluted PE below the mid-20s would be fairer.

Invest In Paychex For Peace Of Mind - Final Thoughts

PAYX's $118.67 share price is down from a ~$139 52 week high. The valuation, however, is still a bit rich. Nevertheless, I have acquired another 108 shares at $118.84 in the 'Side' account in which I currently have PAYX exposure; PAYX shares are held in a 'Core' and a 'Side' account within the FFJ Portfolio.

In the grand scheme of things, this is a relatively insignificant purchase. Furthermore, I intend to hold shares for the very long term and am not concerned about having paid up to acquire additional shares.

I intend to acquire additional shares should PAYX shares become attractively valued.

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 PAYX.

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.