Seeking Alpha
Recommended for you:
Dividend growth investing
Profile| Send Message|
( followers)  

Automatic Data Processing, Inc.(NASDAQ:ADP) provides technology-based outsourcing solutions to employers, and vehicle retailers and manufacturers worldwide. It operates in three segments: Employer Services, Professional Employer Organization Services, and Dealer Services. This Dividend Aristocrat has paid uninterrupted dividends on its common stock since 1974 and increased payments to common shareholders every year for 36 years.

The most recent dividend increase was in November 2010, when the Board of Directors approved a 6% increase to 36 cents/share. The largest competitors of Automatic Data Processing include Paychex (NASDAQ:PAYX), Convergys (NYSE:CVG) and CSG Systems International (NASDAQ:CSGS).

Over the past decade this dividend growth stock has delivered an annualized total return of 3.70% to its loyal shareholders.
click on all charts to enlarge

The company has managed to deliver an increase in EPS of 5.90% per year since 2001. Analysts expect ADP to earn $2.52 per share in 2011 and $2.73 per share in 2012. In comparison Automatic Data Processing earned $2.40 /share the company earned in 2010.

The company is expecting to generate higher revenues in 2011 and 2012 as a result of acquisitions, improving client retention rates, and increased North American auto sales, which would boost its Dealer Services segment. While the employment picture in the US is not very rosy at the moment, the economic recovery should lead to additions to jobs in the near term. In addition, the market for payroll outsourcing services is relatively untapped with small and medium sized businesses, which could deliver strong growth for well positioned firms like ADP. International expansion in payroll outsourcing could be another area where ADP could look for to generate growth.

The market for HR Management services, which represent a high portion of ADP’s Employer Services segment, is expected to increase by 4.5% per year until 2014 according to IDC. The market for Business Process Outsourcing, where ADP is trying to expand into, is expected to increase by almost 5% per annum during the same time frame.

The barriers to entry in the payroll outsourcing are very high, as they require sizeable investments in technology and infrastructure in order to process the information for thousands of employees. In addition, this business requires regular investment in technologies in order to stay competitive. This also creates economies of scale for larger processors such as ADP, which further differentiates them from competition.

The company has been able to generate consistently high returns on equity in the 17.50% -25% range over the past decade. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

The annual dividend payment has increased by 14.50% per year over the past decade, which is much higher than the growth in EPS.

A 14% growth in distributions translates into the dividend payment doubling almost every five years. If we look at historical data, going as far back as 1979, we see that Automatic Data Processing has actually managed to double its dividend every five years on average.

Over the past decade the dividend payout ratio has been on the increase, mostly due to the fact that dividend growth was higher than earnings growth. Since the ratio is at 56% now, future dividend growth would be limited by earnings growth and less on the expansion in the payout ratio. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Automatic Data Processing is trading at 22 times earnings, yields 2.60% and has a sustainable dividend payout. The stock is slightly over valued per my entry criteria but I will consider adding to my position on dips below $50.

Disclosure: Long ADP
Source: Dividend Stock Analysis: Automatic Data Processing