Shares of Automatic Data Processing Inc. (ADP, Financial) have fallen more than 14% since the last time I looked at the stock at the end of last year. All the company has done in the ensuing period since has delivered two quarterly reports that easily topped analysts’ estimates.
That said, shares have fallen almost 7%, while the S&P 500 Index has had a double-digit rally year to date.
The good news for investors watching the name is Automatic Data Processing is now trading at a much more reasonable valuation following the decline. Let’s look at why I believe the stock could be offering a more attractive entry point for those interested in the name.
Recent financial results
Automatic Data Processing reported third-quarter results on April 26. Revenue of $4.93 billion was up 9.2% from the prior year and $43 million better than projected. Adjusted earnings per share of $2.52 compared favorably to $2.21 in the same period a year ago and was 8 cents above estimates.
Looking closer at each business segment, Employer Services had revenue growth of 11% to $3.34 billion. The segment margin expanded 80 basis points to 37.30%. This was driven by a 4% increase in pays per control.
Revenue of $1.60 billion for PEO Services reflected a 5% increase year over year. The segment margin expanded 140 basis points to 16.40%. Average worksite employees paid improved 3% to nearly 710,000
Automatic Data Processing also provided an updated outlook to the remainder of its fiscal year. Revenue growth is still expected to be 8% to 9%, but adjusted earnings per share are now forecasted to be up 16% to 17% for fiscal 2023, compared to 15% to 17% previously. This equates to around $8.17 for the fiscal year.
Takeaways from earnings results
Automatic Data Processing’s most recent quarter continues a string of reports that has shown it has outperformed the market’s expectations.
The company also raised the low end of its earnings guidance for the fiscal year. The midpoint of revised guidance calls for 16.50% adjusted earnings per share growth for fiscal 2023. This is above the company’s five- and 10-year compound annual growth rates of 11.50% and 10.70%, respectively, according to Value Line.
Automatic Data Processing is projected to outperform both its long-term and medium-term growth rates. This is because the current environment remains conducive to the company. Unemployment remains very low at 3.70% as of the most current reading. As a result, many employers are struggling to find enough people to hire.
The closer to full employment the economy is, the better Automatic Data Processing will likely perform as it can provide more benefits and payroll services to as large a pool of employees as possible. This was seen in the most recent quarter when pays under control and average worksite employees both grew by a low single-digit figure, showing the company's clients continue to grow their headcounts. It should be noted the most recent quarter saw a sequential decline in pays under control in the U.S., though just a modest drop from 5% in the second quarter.
Even the Federal Reserve's aggressive action over the last year or so to fight inflation have been a benefit to the company. Higher interest rates have acted as a tailwind to Automatic Data Processing’s results. For example, the average yield on client funds was 2.5% in the third quarter, up from 1.2% in the prior year. The difference in yields is substantial in just one year and even more telling when average client funds totaled more than $39 billion in the period.
Automatic Data Processing ranks very well on a variety of metrics according to GuruFocus, which results in the stock receiving a GF Score of 94 out of 100. Companies with higher GF Scores tend to outperform those with lower rankings, according to research by GuruFocus.
Automatic Data Processing has a perfect 10 out of 10 on growth from GuruFocus, primarily powered by industry-beating revenue increases over the last three years. The company scores a 9 out of 10 for profitability, where Automatic Data Processing easily beats most peers on nearly every metric, including operating margin, net margin and return on equity. Most scores are also near the high end of the range for the last decade. Automatic Data Processing has middle of the road scores in the areas of financial strength, momentum and value.
Valuation analysis
Following the mid-single-digit decline year to date, Automatic Data Processing is trading with a price-earnings ratio of 27.10 off expected earnings per share of $8.17 for the fiscal year. While elevated, the multiple is now below the stock’s five- and 10-year average price-earnings ratios of 29.2 and 27.5.
The stock is now trading below its GF Value Line as well.
Automatic Data Processing currently trades hands at $221.32. With a GF Value of $250.78, the stock has a price-to-GF Value ratio of 0.88. Reaching the GF Value would reward shareholders with a 13.30% return. This is before factoring in the dividend aristocrat’s market-beating yield of 2.30%.
Final thoughts
Automatic Data Processing has underperformed the S&P 500 Index so far in 2023, but the company’s business performance remains very strong. The most recent quarter showed growth in almost every area and the company also boosted the low end of its earnings guidance.
When I discussed the stock in December of last year, shares were trading above their medium- and long-term average price-earnings ratio as well as their GF Value. Now, Automatic Data Processing is trading below all of these metrics.
For investors who were waiting for a better price point, Automatic Data Processing now appears more reasonably valued, which could make the stock an enticing option.
