Automatic Data Processing Posts Strong Growth in Quarter

Automatic Data Processing (ADP) reported solid fiscal second-quarter results Wednesday morning. Revenue growth was 9%, and EPS of $0.78 were about $0.01 above our estimate, although the $0.01 of upside is mainly attributable to a lower-than-expected tax rate. The fastest-growing part of the company remained the PEO segment (up 14%, 18% of total revenue), but revenue growth also was slightly better than expected in the core Employer Services segment. We believe that the increasingly complex regulatory environment (particularly as the Accountable Care Act gets implemented) is creating a strong demand environment for PEO solution.

With the exception of a slight increase to its revenue growth guidance for the PEO segment and a slight increase to the margin expectation for the Employer Services segment, management maintained its fiscal 2014 guidance for overall EPS growth. The one negative for the quarter was that bookings growth for the employer services and PEO segments remained a little lower than expected. Bookings growth was just 1% in the fiscal first quarter and then 7% for the second quarter, so management said that it now expects annual bookings growth to be at the low end of its 8%-10% target.

Management said that bookings growth in the PEO segment and for small and midsized businesses (where the company’s RUN and Workfoce Now products are having success) remained strong, but the company’s bookings with larger companies are still lagging (after being fairly strong in the second half of last fiscal year). Given these trends, we are keeping our 2014 EPS estimate unchanged at $3.15 (up 9%), and increasing our fiscal 2015 EPS estimate by $0.02, to $3.44 (up 9%).

Shares of ADP trade at 22 times our next-12-months’ EPS estimate, which compares with its long-term average P/E multiple of about 18-20 times and Paychex’s (PAYX $40.74; Outperform) forward P/E of 23 times. The company’s dividend yield is 2.6%. ADP continues to deliver solid, steady results, its traction with some of its newer SaaSplatforms in the small and midsized markets is encouraging, and the headwind from interest rates will start to abate in a year or two. However, the stock is already trading nicely above the company’s normal P/E range of 18-20 times, and we do not anticipate significant upside potential to earnings projections; so we see better risk/reward profiles elsewhere in our coverage universe. Our rating remains Market Perform.