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Morningstar | No Sign of Recession in Paychex's 4Q

Wide-moat Paychex finished up its fiscal 2019 modestly below our 2019 forecast sales while slightly outperforming below the line, earning $2.86 per diluted share. For the fourth quarter, Paychex generated sales of $980 million representing year-over-year growth of 16%. Excluding revenue from the acquisition of Oasis, the company would have generated revenue growth of 5%. This quarter’s growth is modestly below our long-term forecast for sales growth of 5.5% to 6%. The best thing we heard during the call is that Paychex’s customer base hasn’t seen noticeably slower hiring which conflicts with other indicators that the country could be headed for a recession. If anything, Paychex management signalled its customers were having trouble finding workers to fill openings. This might suggest that wages will march higher. Regardless, this quarter’s performance doesn’t alter our long-term view for Paychex, and we will be maintaining our fair value estimate of $60 per share. Currently, we view Paychex as expensive, as shares in the company trade at more than a 30% premium to our fair value estimate.

During the quarter, management provided its initial 2020 outlook for the company forecasting revenue growth of 10%-11% and earnings growth of 8%. This is higher revenue growth than we were anticipating, but management’s guidance does suggest lower operating margins than we had forecast. Most of that is attributable to Paychex’s shifting revenue mix toward its PEO business. Net these two items, it will not materially change our valuation of the company. Excluding the impacts of the Oasis acquisition, Paychex’s growth profile remains mostly unchanged. The company expects payroll to grow at 4% while PEO and insurance revenues will grow at 11%-14% once the company reaches the anniversary of its acquisition in the second quarter. This is broadly in line with recent growth despite the impact of slower revenue growth as worker’s compensation rates decrease.

There were two noticeable positives for Paychex in the quarter. First, the company does appear to be gaining some traction with mid-size clients where the company saw improved growth. Management attributes this growth to new products, specifically citing client adoption of data analytics. The other key positive is Paychex doesn’t appear to have seen higher losses or higher reserves from worker’s comp resulting from the labor market or its acquisition of Oasis. This is one of the better forward indicators of a weakening labor market. In recent years, reserves for worker’s compensation claims have been minimal, which has provided some benefit to Paychex’s margins. In a recession, we would anticipate margin pressure as reserves rise, but this quarter gave us no reason to believe this is imminent.