Paychex (PAYX) fails to impress investors despite positive financial performance

Paychex, Inc. (NASDAQ: PAYX), a leading provider of human capital management solutions,  performed well in 2020 despite the unfavorable operating conditions. Taking advantage of its unique platform, the company achieved stable customer retention that resulted in strong earnings performance. It also maintained positive margins throughout last year. However, the performance of the stock has not been very encouraging.

With the recent rally in the markets, Paychex’s price has gotten ahead of its value. The stock returned 26% in 2020, outperforming the industry’s 22.5%, but it dropped about 4% in the last 30 days. The downtrend continued ever after the positive quarterly report as investors took a cautious stance due to the COVID-related uncertainty and lack of clarity over the company’s future. However, the long-term prospects look good.

In the second quarter, earnings per share of $0.73 were better than the analysts’ estimates of $0.66. Revenue for the quarter came in at $983.7 million versus the consensus estimate of $954 million.

Tackling COVID

As the nation was grappling with the unexpected impact of coronavirus, Paychex increased the use of its specific resources to grow online and mobile capabilities, enabling both employers and employees to access its tools with ease.

“Small and medium-sized businesses are the engine of the U.S. economy, and we will do everything we can to help them get through this turbulent time,” said Martin Mucci, Paychex’s CEO, in the earnings report.

Since the U.S. was badly hit by the COVID crisis, Paychex’s expertise in the client’s business activities helped it maintain constant revenue flow. The company experienced a massive increase in the adoption of its mobile platform Paychex Flex.

Paychex has provided around 670,000 businesses with access to a variety of services and solutions that supported them through the COVID-19 crisis, including:

1. Compliance support to organizations
2. H.R and payroll guidance that helped clients explore new areas
3. Easy access to employees to cash whenever needed
4. Helping workers to evolve and provide HR tools

Strong Numbers

The company raised its guidance after second-quarter results showed a sequential improvement in financial performance and key business metrics. Net income increased 5% to $272 million or $1.1 per share, while expenses decreased by 3% to $629 million. The decline in expenses was driven by lower headcount, discretionary spending and facilities cost as a result of our cost-saving initiatives. Management Solutions revenue increased 1% to $732.8 million.

Risk for Paychex

Paychex’s biggest risk is tied to the economy and its relationship to the labor markets. Restaurants that employ 15-50 persons constitute a  large part of the small business world. So, the struggles of those businesses during the pandemic reflects in the performance of Paychex. With more and more businesses going out of operation, the closures will impact Paychex. Although not as obvious as in the case of small-to-medium businesses, Paychex’s exposure to possible data breaches is another risk as payroll processors are a prime target for those wishing to steal sensitive data, and any breach would be devastating for Paychex’s reputation.

Outlook

Outlook for the fiscal year ending May 31, 2021, incorporates anticipated impacts from the COVID-19 pandemic, based on current assumptions and market conditions. Changes in the macroeconomic environment could alter guidance. Total revenue is anticipated to be in the range of -3%) to flat and earnings per share are anticipated to be in the range of -1% to -4%. Earnings per share exclude tax benefits on stock-based compensation payments of $15.5 million.

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Read management/analysts’ comments on quarterly earnings

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A Buy Bet or Sell?

The biggest takeaway for investors is the recent upgrade of earnings per share guidance, which suggests a clear improvement in sentiment around Paychex’s earnings potential next year. Analysts also reconfirmed their revenue estimates, suggesting sales are in line with expectations. Currently trading at $94.06, the stock is expected to reach $96.02 in the coming quarter, aided by the strong financials.