Automatic Data Processing Puts Up Impressive Numbers

Automatic Data Processing (ADP) continued its strong performance as a company in their fiscal second quarter of 2008, posting 15% year-over-year revenue growth and 22% earnings growth from continuing operations. In addition, ADP guided to 12-13% revenue growth, and 18-21% diluted earnings per share growth in 2008. The market is certainly not pricing the company as if it expects these targets to be achieved. ADP also continues to pay a $0.29 per share dividend per quarter. That’s over a 3% dividend yield.

Quarterly Highlights

In the first two quarters of 2008, ADP has re-purchased over 18 million shares at a cost of $842 million. I view this as a shareholder friendly practice that drives growth in earnings per share.

ADP’s flagship Employee Services division reported an 11% increase in revenues on a year-over-year basis. Their “beyond payroll” revenues grew at a 16% rate in the US.

ADP had its PEO Services segment grow revenues at a 22% rate. Average worksite employees paid increased to approximately 170,000, representing 20% growth over the prior year.

Dealer Services Revenue grew at a 9.5% rate with margins improving as well. Client Funds revenues grew at a 14% rate to $162 million. This is just interest on float that ADP earns, which will be negatively impacted by lower short-term rates this year. Still, there was an 8.9% increase in average client fund balances.

All segments of ADP’s business look to be performing well. If this rate of growth continues, shares could double in five years.

Trailing-Twelve Month Owner Earnings

ADP’s trailing twelve month numbers are as follows:

Capital expenditures for the 2nd quarter were not reported. I have estimated capex based on the past three quarters of history.

Valuation

In order to determine an intrinsic value of ADP, I start with owner earnings of $2.19 per share. I then apply a 5-year growth rate, followed by a terminal growth rate for years 6-30 of 5%. I discount the series of cash flows back at 10%.

Using 5-year growth rate of 5%, followed by terminal growth rate of 5% results in a value of $35 per share. This is about as conservative as you can project given the consistency of ADPs performance.

Assuming ADP cannot hit their guidance and only grows at a 12% rate for 5 years, the value is $46 per share. The market seems concerned that unemployment will rise, and stall ADP’s growth. A 12% growth rate assumes that they hit some headwinds, but over the course of the next five years, they continue double-digit earnings per share growth.

Finally, I want to assume that ADP hits their guidance and can maintain strong earnings per share growth due to continued buybacks and growth in their less mature businesses such as PEO services. Here I assume 18% growth for five years and get a value of $59 per share. Keep in mind that ADP generated 22% year-over-year growth in continuing operations per diluted share in their most recent quarter. A 25% margin of safety here still results in a value of $43 per share. This still looks achievable for ADP.

Conclusion

The market certainly seems to be a bit irrational in regard to ADP at this time. It is rare to get a chance to buy this company on sale, so now continues to be a good time to add shares for the long term. Don’t forget the nice 3% dividend yield as well.

Disclosure: Long ADP