Paychex Earnings: Revenue Growth Driven By Health Insurance, Pricing

Paychex (NASDAQ:PAYX) released its fiscal first quarter earnings results on Wednesday, September 30, reporting an 8% annual increase in net revenues to $723 million. Growth was largely driven by the company’s Human Resource Services (HRS) segment revenues, which were up by 15% year-over-year to nearly $280 million. On the other hand, Payroll services revenues grew at a steady 5% y-o-y to $432 million for the quarter. ^[1] Despite the slight dip in the small business job environment in the last few months, the company continued its steady growth in the payroll division.

Paychex’s operating expenses were up by about 7% y-o-y through the quarter at $427 million. On the other hand, the effective tax rate for the quarter was significantly lower than the prior year period due to a net tax benefit from customer software used in previous quarters. ^[2] As a result, the company’s EBITDA margin improved for the quarter on a y-o-y basis. According to our estimates, Paychex’s adjusted EBITDA margin was about 40 basis points higher than the year-ago period at 45.1%.

We currently have a $48 price estimate for Paychex’s stock, which is in line with the current market price.

See our complete analysis of Paychex here.

Human Resource Services Continues Growth Spree

Paychex’s HRS revenue grew 15% in the quarter ended August to reach nearly $280 million, reflecting strong growth in worksite employees and the number of clients serviced. The company witnessed robust growth in insurance services, retirement services and product sales for administration and time & attendance products. Most of Paychex’s products are sold as bundles within the Administrative Services Organization (ASO) or professional employer organization (PEO) product categories.

A key reason for the growth in HRS revenue was the Patient Protection and Affordable Care Act (PPACA), which includes a regulation wherein many employers are required to provide health insurance to employees. According to research conducted by Automatic Data Processing (NASDAQ:ADP) earlier in the year, around half of the large employers (1,000+ employees) in the U.S. were unprepared to comply with the regulations of the PPACA. ^[3] Paychex management believes that the company’s growth in this segment outperformed the market through fiscal Q1 and contributed significantly to higher HRS revenues. As businesses continue to work to comply with the PPACA, Paychex’s insurance offerings should continue to grow.

Payroll Division Maintains Steady Growth

Although the broader job market has remained strong this year, the environment for small businesses (less than 50 employees) has weakened slightly in the last few months. The Paychex IHS Small Business Index, an indicator of change in small business employment in the U.S., declined by 0.4-0.5% in each of the three months during fiscal Q1. ((The Paychex | IHS Small Business Jobs Index, Paychex Report, September 2015)) Despite the slight dip through the quarter, the company remains hopeful about future growth in small business. ^[4]

Payroll revenue grew by 5% y-o-y to reach $432 million, close to the upper end of the company’s guidance for the quarter. The growth was attributable to improvements in pricing and a steady increase in its client base. At the beginning of last year, Paychex indicated that its pricing increase was in the 2-4% range, which it has sustained through FY 2015 and Q1 FY 2016. ^[5]

Paychex’s payroll clients increased by 2% over the previous year to 590,000 at the end of FY 2015. We believe that Paychex is likely to see continued growth in its client base since as more companies outsource their payroll. Outsourcing allows these companies to focus on their core businesses and also generally benefit from reduced operating costs. Additionally, companies such as Paychex are better equipped to deal with the complexities of various regulations. We currently forecast Paychex’s payroll clients to increase at a steady rate through the end of our forecast period.

Outlook For Fiscal 2016

The Insured Unemployment Rate (IUR) represents the portion of the labor force that is eligible to receive unemployment insurance. It is considered to be a leading indicator of unemployment conditions in the U.S. The seasonally adjusted IUR has been declining consistently since 2008 and has fallen below 1.6%, lower than the pre-recession IURs . ^[6] As a result, there may be further declines in the unemployment rate in the coming quarters.

However, Paychex could be affected by an inconsistent pattern in the growth for small business jobs. While many of the causes of the weakness were temporary and have faded, the slowdown in mining and oil and gas industry hiring will likely persist. In addition, concerns over wage growth will continue to put pressure on small businesses. Even so, Paychex’s pricing increases and steady growth in its client base is likely to continue to help drive its top line. The company has maintained its guidance for the full year – payroll revenues are expected to grow at 4-5% while HRS revenues could rise by 10-13% through fiscal 2016 .

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1. Paychex Q1 FY 2016 Earnings Release, Paychex Press Release, September 2015 [↩]
2. Paychex SEC Filings 10-Q For Q1’16, SEC, September 2015 [↩]
3. One in Two Large Employers Unprepared to Fully Comply with the Affordable Care Act, ADP Report, January 2015 [↩]
4. Small business is back: Paychex CEO, Yahoo! Finance, September 2015 [↩]
5. Paychex (PAYX) CEO Martin Mucci on Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, September 2014 [↩]
6. Unemployment Insurance Weekly Claims Data, US Dept of Labor, October 2015 [↩]