EUR 850.00 For Business Accounts Only

Morningstar | With Slowing Growth in Payroll, Paychex Focuses on Its Faster Growing PEO Business

Paychex’s niche of providing payroll solutions to small businesses remains immensely profitable. With revenue growth that is routinely in the mid- to high-single digits and EBIT margins just below 40%, this company continues to benefit from its expansive scale and the low incremental costs of providing payroll and new offerings to customers. It is not surprising this profitability has attracted competitors. We've become impressed with increasingly capable do-it-yourself software solutions and younger competitors in Paylocity and Paycom, which we believe represent a growing threat to steal price-sensitive small businesses. We do not believe Paychex will benefit from increasing employment as it has historically done. In order to maintain its edge, we believe Paychex will need to increase its capital spending, improve its capabilities, and expand its service offering. To us, it appears Paychex's payroll looks increasingly challenged and we understand the company's efforts to focus more on its paid employer organization. In recent years, much of the company’s growth has been attributable to human resource services where the company has become increasingly acquisitive. Revenue in this segment has compounded at more than 14% over the past five years, and much of this growth has been attributable to companies that are seeking to outsource parts of their HR department or access other cost savings. In addition, many small businesses have used Paychex’s professional employer organization to assign new and existing employees to Paychex as if these employees were really employed by Paychex, in order to gain better pricing on healthcare and employee benefits. Finally, we do anticipate that interest rates will serve as a tailwind over time. Paychex generates interest income on all employee withholdings. In the precrisis period, Paychex had realized yields of nearly 3.5% on these cash balances. In fiscal 2018, Paychex realized yields on cash balances of 1.6%, we believe yields will eventually reach 2.5%, providing an additional $50 million in earnings that will fall directly to Paychex's bottom line.