Paychex Q3 Earnings Do Not Include March Results
Considering the strength of the March NFP report we really thought Paychex (NASDAQ: PAYX) would have reported a better quarter. In hindsight, though, that expectation was misplaced because the Paychex Q3 period ended in February and well before the March surge in hiring began. Even the KC Fed’s Labor Market Conditions Index failed to capture the strength, so much so that it included a statement to the effect the February read does not reflect the current state of labor market conditions.
“These readings likely do not fully describe the state of the labor market at the end of February, as many of the input data series reflect conditions early in the month. In particular, the series does not include the effects of the decrease in new COVID-19 cases or the acceleration in vaccine administration that occurred later in the month ... Therefore, labor market developments in the latter half of February, including the labor market response to recent COVID-19 developments, will likely show up in the March 2021 LMCI readings.”
The takeaway here is simple. Paychex Q3 results weren’t as strong as we thought they could be but Q4 surely will. Hiring has picked up strength and, based on the company’s internal metrics, that strength is going to result in highly leverage revenue and earnings growth the analysts have yet to factor in. In our view, this company is not only set up to beat the consensus but by such a wide margin it will impact the consensus estimates for next year and the year after as well. That situation will drive share prices higher over the long term.
Paychex Revenue In-Line, Earnings Beat
Paychex’s 3rd quarter revenue grew sequentially for the 4th quarter to $1.11 billion. This is shy of the YOY comparison by 2.6% but this is the last quarter of hard comps. Not only do we expect the next quarter’s revenue to accelerate sequentially again but the comp to last year is against the calendar Q2 period when shut-downs were at their worst.
The details we like most show that revenue is down due to a decrease in spending per client associated with smaller workforces and not because of client loss. Regarding client loss, the company says retention is strong and that its client base has actually grown in the last year. In this scenario, coupled with an increase in the number of services offered, the March 2021 wave of hiring should produce accelerating revenue growth in the 4th quarter and revenue above well above the pre-COVID level.
Moving down, the company was able to reduce and control its expenses over the past year and quarter. This led to a 4% improvement in SG&A expenses and a 1.1% increase in Operating Income. On the bottom line, the improvement in margin can be seen in both the GAAP and adjusted earnings. GAAP EPS of $0.97 beat by a nickel while the adjusted $0.96 beat by $0.04.
Paychex Dividend Is Attractive And Safe
Paychex pays an attractively high-yielding dividend that is much safe than it may appear. At face value, the company is paying out 85% of its earnings which is a bit high but there is this to consider. The company has very little debt, more than enough cash to pay it all off, ultra-low leverage, a high coverage ratio, ample FCF, and growing earnings. In our view, this dividend is as safe as they come and one that may see an unexpected increase in the not-too-distant future.
Shares of Paychex are down -5.0% following the Q3 release and we think this is a knee-jerk reaction to some news that should have been expected. In that light, the stock is offering a potential entry point for new money but we suggest waiting for support to confirm before buying in. The best first target for support is near the $92 level, if that is breached a move to $88 may be in the cards.
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