Sunday, March 8, 2009

ADP: The Single Source Solution

Automatic Data Processing, Inc. (ADP) is the leading business outsourcing provider in the human resources, payroll, tax, pension and benefits administration space. ADP also provides industry-specific solutions to automotive, heavy truck, motorcycle, marine and recreational vehicle dealers. The company operates in three segments: Employer Services, Professional Employer Organization (PEO) and dealer services.

The company is beginning to see the effects of massive layoffs throughout the economy. While they are suffering from fewer payroll transactions and being challenged with customer retention issues which will only accelerate as unemployment ratchets up from 8% to a projected 10% level, we feel these challenges are temporary. When the economy recovers and employment returns to more normal levels, ADP will see sales and earnings growth return to higher levels. While we wait for the economy to turn around, ADP retains some pricing power and is able to increase its pricing.

Dylan Cathers, the analyst at Standard & Poor’s projects FY 09 earnings at $2.41, two cents more than the consensus forecast of $2.39. Cathers also sees sales growth continuing at the 3.5% rate in FY 09.

Valuation
Historically, ADP has traded at a richer multiple than it does now. Regardless of which metric you favor, the company sells at a premium to its industry.


TTM 1 Year 3 Year 5 Year 7 Year
Price/Earnings 14.30 20.20 23.80 25.40 24.10
Industry P/E 10.10 16.80 22.20 24.20 23.60

Price/Book 3.46 4.04 4.28 4.21 4.20
Industry P/B 0.90 1.80 2.40 2.50 2.30

Price/Sales 1.86 2.51 3.01 3.19 3.16
Industry P/S 0.50 0.90 1.30 1.40 1.20

Price/Cash Flow 9.60 16.60 19.80 20.90 19.60
Industry P/CF 7.40 14.60 17.70 18.50 18.50

Price/FCF 17.40 36.00 31.60 30.70 28.50

Growth

The company has a history of consistent growth for sales, earnings and free cash flow.


TTM 3 Year 5 Year
Sales 8.80 12.70 4.20
Gross Income 6.00 11.10 3.70
Net Income 29.30 5.40 3.90
Dividends 22.40 21.70 18.00
Cash Flow 43.80 19.00 4.50
Free Cash Flow 72.10 7.80 2.90

Ratios

The company has a strong balance sheet with little long term debt even though ADP repurchased 33 million shares in 2008.


Current Jun-08 Jun-07 Jun-06 Jun-05 Jun-04 5 Yr Avg.
Gross Margin (%) 54.70% 55.40% 56.50% 56.50% 57.80% 54.50% 56.14%
Operating Margin (%) 0.20% 20.60% 20.80% 19.90% 20.20% 19.70% 20.24%
Net Margin (%) 16.80% 14.10% 14.60% 22.70% 17.20% 12.90% 16.30%
ROE (%) 29.90% 24.10% 20.40% 26.30% 18.80% 17.30% 21.38%
ROA (%) 5.30% 4.90% 4.20% 5.60% 4.30% 4.60% 4.72%
Current Ratio 1.10 1.10 1.10 2.10 1.70 1.60 1.52
Payout Ratio (%) 41.00% 46.40% 42.50% 26.30% 33.70% 34.20% 36.62%
Liabilities/Assets (%) 85.50% 78.60% 80.70% 78.10% 79.10% 74.30% 78.16%
Asset Turnover (X) 0.30 0.30 0.30 0.20 0.30 0.40 0.30

Conclusions
We see the company as having a strong balance sheet capable of sustaining ADP through the next year or two. ADP’s prospects are bolstered by strong and steady free cash flow and a recurring revenue stream. Competition is stiff in this industry but ADP is the leader and, we expect, will remain so.

Our fair value estimate for ADP is $72.50. This is based on our estimate of free cash flows over the next twelve months of $1.82, the expectation of continued growth in sales and earnings and our assessment of the balance sheet.

Disclosure: At the time of writing, author has no position in ADP.
Seeking Alpha Certified