ADP Earnings Preview: Employment Growth Expected to Drive Top Line

| About: Automatic Data (ADP)

Automatic Data Processing (NASDAQ:ADP) is set to release Q2 FY 2013 earnings on Tuesday, Feb. 5. The company has reported year-over-year increases in revenues for six straight quarters, posting Q1 organic revenue growth of 3%. Since ADP's primary business involves payroll processing, its revenues are dependent on new business and employment growth in the United States. This correlation with employment might help ADP's revenue growth during the second quarter as the U.S. economy experienced a decrease in unemployment rate. The U.S. unemployment rate shrunk from 8.1% in September to 7.8% in December, and we think this will provide a boost to the number of employees on ADP's client payrolls.

Due to this recent trend, we will closely watch the average number of employees on ADP's client payrolls to determine whether or not a strengthening job market has impacted the company's performance over the last three months.

Client Payroll Growth

One of the biggest drivers in ADP's Payroll Processing division, which constitutes approximately 76% of the company’s value, is the average number of employees per account. If increasing employment in the United States has translated to payroll growth among ADP's client base, it could provide upside to our top-line growth estimates. We think that one of the best proxy's for ADP's results is another payroll processor, Paychex (NASDAQ:PAYX). The company announced earnings at the end of December and posted revenue growth of 5% year over year.

Small Business Client Growth

Another aspect of ADP's business we will be closely watching is the revenue it generates from small businesses. Small business employment growth increased during the quarter with the addition of 25,000 jobs in December. This is an encouraging trend for ADP because small business growth and employment create a feedback loop in the overall economy and have been the drivers of economic growth in the past.

We will also be closely watching the progress that ADP's partnership with Xero has made. ADP entered into this partnership in July 2012 to specifically target small businesses, and we think that ADP's focus on pushing its services to the cloud will attract new clients because it makes it cheaper for small businesses to outsource payroll. We think these are important developments as we expect the company's small businesses segment to be a key growth driver in the coming years.

We currently have a $60 price estimate for ADP, which is approximately the same as the current market price.

Disclosure: No positions.

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Tagged: , Business Software & Services, Earnings
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