Software // Enterprise Applications
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10/29/2004
06:20 PM
William Schaff
William Schaff
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Taking Stock: Slow And Steady ADP Wins Earnings Race

Back-office processing for many firms often runs on ADP support.

It's hard to get too excited about stocks when the year-to-date returns for the broader equity market as represented by the Standard & Poor's 500 and the Dow Jones industrial average are bouncing around zero for most investors. Despite all the turmoil, there are still some names--even within technology--that have come out on top. One of them is Automatic Data Processing, the largest payroll-processing and employer-related services company in the world. And some other business lines also are doing well, such as brokerage services and dealer services.

In my opinion, ADP isn't as exciting as many other technology names. It just seems to grow steadily each year. During the most recent fiscal quarter, ending in September, it reported revenue of almost $1.85 billion, up 8% over last year. Roughly 63% of its revenue is associated with employer services, which include payroll processing, benefits administration, 401(k) record-keeping, and tax services. ADP's second-largest line of business is brokerage services, representing about 18% of its total revenue. Many investors don't know that much of the back-office processing of many financial firms is supported by ADP software and services. The company handles everything from order management to regulatory issues and settlement of trades. I'm used to working on its Merrin trading system, which has substantial compliance overlay to minimize trading errors. In our ever-increasing regulatory world, these systems are becoming more mission-critical for asset-management and other financial firms.

Dealer services is the company's third-largest business line, representing about 13% of total revenue. This includes everything from an online automotive-electronic-parts catalog to automated dealership document processing. ADP serves more than 17,000 auto and truck dealers.

However, the company hit a bump on the earnings growth road in 2003. It was the first year in quite a few decades when earnings growth fell off. The result? The stock price went from a high of $40 at the beginning of 2003 to a low of $27 in March and has since clawed its way back up to the current levels of $43, a round-trip that took almost two years.

The stock has traded at a premium on a price-to-earnings ratio basis as well as on most traditional valuation metrics such as discounted cash-flow valuations. Fiscal sales for the year ending June 30 were $7.76 billion. I estimate, based on company projections of 7% to 8% revenue growth in fiscal 2005, that revenue will be close to $8.34 billion. Analysts' fiscal 2005 earnings estimate, based on First Call, is $1.77 per share. At $43, the 2005 P/E is 24.3 times, a nice premium to the S&P 500 P/E multiple of 19.4 times.

But ADP expects earnings to expand more than 13% from last year's earnings level of $1.56 per share. This is substantially greater than the S&P 500 earnings growth projections of 6% to 8%. The company also benefits from an expanding economy. It wouldn't surprise me to see upward revisions to earnings estimates as the economy improves. In my opinion, the stock is trading at fair value today, but it looks like a high-quality stock for most investors. I don't say that very often.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at william.schaff@bayislefinancial.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.

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