$PAYX Earnings Reports Q3 2022

$PAYX Short

Sep 27, 2022

Paychex is a New York-based company that provides payroll to 730,000 total payroll clients, approximately two million worksite employees served through their HR outsourcing services, and over 100,000 retirement clients. The stock is currently valued at around $125.00 a share which puts a giant market capitalization of just about $45 billion.

On June 29th, the company posted its fourth-quarter results with an EPS of 81 cents a share, two pennies above estimates. Revenues also rose nearly 11% on a year-over-year basis to $1.14 billion, around $30 million above the consensus.

Management Solutions revenue was the biggest of overall sales and increased 12% to $845.3 million for the fourth quarter and rose 14% to $3.4 billion for the year. The rest of the company revenues came from Professional Employer Organization ("PEO") and Insurance Solutions. This increased 10% to $284.3 million for the quarter and was up 14% to $1.1 billion for the fiscal year. Client retention remained above management expectations as well as pre-pandemic levels. Generally speaking, they had a great quarter. Management’s forward guidance expected revenue to grow in the range of 7% to 8% this fiscal year, which was pretty much in line with analyst expectations.

However, the analyst community is not very happy about the company's situation right now. Since late June, ten analyst firms including Morgan Stanley and JPMorgan have changed their opinion on the stock to Hold, Sell, or Neutral. Currently, the only two firms issuing a buy target on the stock are only Cowen & Co. and Credit Suisse. Only approximately three percent of the shares are currently shorted. Insiders have also quickened the pace of sales in recent months. Numerous insiders have sold over $10 million worth of stock since July. The last insider purchase in the equity was back in October 2018.

The company boosted its quarterly dividend by 20% in April of this year to 79 cents per share per quarter. During the company's final quarter of FY2022, Paychex returned around $430 million to shareholders in the form of dividends and stock repurchases so I would say the company's balance sheet is in good shape.

Now, with all those numbers in mind, let’s jump to why I believe this company should be shorted. Although there have been considerable macro headwinds recently with the U.S. GDP becoming smaller over the last two quarters straight and the Fed continuing with interest rate hikes, Paychex’s business has held up quite well as the labor market has remained strong as we saw in the reports released by the fed. This has resulted in an expanding base of payroll clients and continued demand for the company’s HR solutions. For Q4 FY 22 (the quarter ended May) Paychex results came in ahead of estimates, with the company’s key operating metrics being higher than expected. Total worksite employees rose 18% versus last year to 2 million, with client retention standing at a strong 88%. The company had about 730,000 total payroll clients and over 100,000 retirement clients as of the end of May. Now, the job market remained relatively strong over the last quarter as well. In August, employers in the U.S. added about 315,000 jobs, with the unemployment rate standing at just about 3.7%, down from 5.2% in the year-ago period and this is likely to be great as well for Paychex’s business. However, profit margins will be a key factor to watch. While adjusted operating margins remained roughly the same year-over-year at 34.4% in Q4 FY 22, it’s possible that inflationary pressure could impact it as we saw with most other companies. There is a strong probability that the U.S. will enter a recession very soon, and the company is also expecting that sales will decrease versus their all-time highs, guiding a growth rate of 7% to 8% for FY’23, down from close to 14% growth in FY’22. Management also expects that adjusted earnings for FY’23 are expected to grow at 9% to 10%, down from a growth rate of 24% over the last fiscal year. Paychex stock also trades at a relatively high multiple of about 30x consensus 2022 earnings. While this is justified by the company’s relatively predictable earnings growth and stable dividend, the high valuation could prove a risk for the stock, especially in the current economy. As we have seen countless times, the only thing investors are currently looking at is what the company has lined up for the future and the future isn’t looking too bright for Paychex. They are highly overvalued with the stock trading at ten times revenues for a firm that is projected to have mid to high single-digit sales growth in FY2023. The stock pays around a three percent dividend yield but that’s not justifiable here at these valuations with a long-term earnings growth rate of 10%

Add in the recent insider selling and an unhappy analyst community, there is no reason to own PAYX at these levels. It is also important to note that over the last 2 years, Paychex has beaten EPS estimates 100% of the time and has beaten revenue estimates 100% of the time so this will also be expected this quarter. I believe this will come to our advantage as this is a normal thing now and is the bare minimum people are expecting so the main deciding factor here would be their forecast for the rest of the year.

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